Financial Planning

Saving vs Investing

It’s a common misconception that saving and investing are one and the same. They are both key concepts to creating a solid financial foundation, but there are differences between when to save and when to invest.

When to Save

A great rule of thumb is to always save first. It is important to build your cash reserve in your checking and/or savings account so that you can fall back on that cash in hard times. This idea is often referred to as an emergency fund. You want to have three to six months’ worth of necessary living expenses saved in your bank account should you lose your job. Necessary living expenses are the ones that you can’t get rid of. Some examples are mortgage payments or rent, utilities, car payments, and food. If you were to lose your job, you could go without buying new clothes or paying for your Netflix subscription as they are discretionary and as such, wouldn’t go towards your emergency fund calculation.

Once you’ve built your emergency fund, you want to start thinking about your short-term goals. If you have a big expense, like a down payment for a house, within three years, you should consider adding even more to your savings to go towards that expense. The concept here is that you won’t run the risk of losing all or a portion of your cash as you would if you were to invest that amount. Cash in a bank account can earn a little bit of interest, but you won’t ever have to worry about losing what you put in. The one potential risk of losing your savings is if your bank fails, but almost all banks have FDIC insurance, which covers you up to $250,000.

When to Invest

After you’ve built your emergency fund and considered any big expenses within a three-year timeframe, you should then consider investing. When you invest, you’re looking to grow your money beyond what you put in. However, with that comes risk. When you invest your money into the stock and/or bond market, you run the risk of losing all or a portion of what you put in. That is why you should plan to keep your money invested for at least three years because investments can be volatile over short periods. Historically, your chances of growing the money you invest are greater than losing it, but you have to keep that money invested. For some perspective, the average bull market (prices rising) lasts about 2.7 years while the average bear market (prices falling) lasts about 9.6 months. It should always be stated that returns are not guaranteed, and past results are not indicative of future gains.

When looking to invest for the long-term, a good place to start is with retirement accounts like a 401(k) or IRA. 401(k) and IRA accounts are long-term in nature because for most workers, retirement is more than three years away. To earn enough money to sustain your lifestyle during retirement, you want that money to be invested with the idea that it will grow to an even greater amount for when it comes time to start pulling from it in retirement. You won’t be able to reach the desired amount to live off of by keeping your money in cash; rather you need to have it invested. Outside of retirement accounts, you can also look to invest your money in regular brokerage accounts to grow your money, but again, always consider the timeframe for that money.

Ultimately, whether you decide to start saving or investing is up to you. A good habit to begin is to reflect on your financial status now and your goals for your financial future. This will help make the best decision on how and when to start saving, investing, or a combination of both. It’s also a good idea to review these every few years as your preferences are likely to change especially after monumental life changes. To learn more on how we can help you begin a solid financial foundation, please don’t hesitate to contact us.