To Save or Invest; that is the Question
The average individual undoubtedly understands that there is a difference between saving and investing, even if those terms are sometimes used interchangeably. The key to taking advantage of saving and investing is understanding the difference between them. In short, saving and investing differ in terms of risk and liquidity. There is much more to it, including the challenge of determining whether you should save your money or invest for the future.
A Look at Saving
Savings can be simply broken down into one concept: short-term planning. If you are going to save money, it should be geared toward a specific purpose. What exactly qualifies as saving short-term can differ from one individual to the next. Typically, you want to save your money to meet short-term to near-term goals that are attainable within the next 3 years, or less.
If you are unable to think of something you should save for, consider a vacation, new home purchase, a college fund for your child/children, or an emergency fund. It is never a bad idea to have an emergency fund in case you have unforeseeable medical expenses or home repairs. Additionally, as Investopedia points out, having cash reserves at hand means you have liquid assets you can use to pay for these aforementioned expenses.
Overall, saving money not only keeps your assets liquid, but it also provides you a safe growth option. The Federal Deposit Insurance Corporation protects individual savings accounts up to $250,000, and savings accounts earn low amounts of interest. You will not necessarily become rich on your savings, but it will be protected by the FDIC and even earn a little interest while it is sitting in the bank.
A Look at Investing
When it comes time to think about your long-term financial health, you will want to start looking at investment options. Investment is geared toward your long-term goals that are out on the horizon beyond the five-year mark. This includes common things such as retirement, but also larger life goals such as launching your own business.
Investing, like saving, has its advantages and disadvantages. When you invest your cash, that money is often set in accounts that you cannot touch, or pay a penalty for withdrawing too soon. This means your cash is not easily at hand when you need it. Investing also involves risk. The level of risk depends upon the individual portfolios and funds you place your money in, but there is always going to be a risk in doing so.
While you may lose some of your money when investing, the flip side of that is the fact that investing provides you with a greater chance to build more wealth in the future. CNN Money notes that if you invested $1,000 a year starting at age 25 into an account with 7% annual interest, and stopped after 10 years (at age 35), you would still have a nice haul. That account, with no further investments after 10 years and an average 7% rate would accumulate $113,000 by the time you retired.
Defining Time Frames
Most experts use the 5-year timeframe as a guideline when differentiating between saving and investing. If you are going to need your money in the next five years, set it aside in a savings account. On the other hand, if you will not need it in the next five years, then it is best suited for an investment portfolio.
Finally, keep in mind that while the stock market has ebbs and flows that might scare you away in the short-term, it performs very well long term. Historically, the stock market has made money in 93% of five-year timeframes. Out beyond the 10-year timeframe, it makes money compared to initial investments 100% of the time. Remember, the closer you get to retirement, the more you need to think about shifting your money to safe investment vehicles. Contact Scott Kahan, CERTIFIED FINANCIAL PLANNER™ of Financial Asset Management Corporation for more guidance with your savings and investments.