Most of us know there is a difference between savings and investing. It makes sense; we hear the two words all the time. But what we don’t know is how the two work together, and how the two should be managed.
The difference between savings and investing is simple! If you need it soon, save it! If you don’t, feel free to consider an investment.
So what is soon? Well there is no perfect answer to that. But as a guideline, if you need it in 5 years or less, it should be saved. If you don’t need it for 5-10 years or more, consider investing.
What is Savings?
When you put money into savings, your first priority should be preserving the money! Your savings is short-term by nature. You want to put your money in places that are:
- Easily accessible – you can get to it right away.
- Guaranteed – not to lose money.
- Liquid – no penalties or surrender charges.
Said another way, put it in the bank. BORING. I know!
Considering you need this money safe, liquid, and accessible, you need to understand you will not be earning much interest. Low risk = low reward. But that’s OK. That’s what a savings account should be: a place where you don’t lose money.
What Do We Save For?
Depending on our likes, interests, families, jobs, etc… our purpose for saving could be a lot of different things. First and foremost, I encourage my clients to save enough to have an emergency fund (read more here).
Next, think things like a house, a car, or a vacation.
Whatever it is, having adequate savings is critically important to the process. Consider savings the base of the financial planning pyramid. You want to have a decent savings prior to jumping into the investment world.
What is Investing?
Investing is used to build wealth. Investing is long term.
Investing exposes you to market volatility. When you invest in the market, you are assuming risk that the investment can go down in value. For that risk, you expect that you will earn a higher rate of interest. If all goes well, the rate of interest you earn will exceed that of the bank, inflation, and other similar investments.
Investing is often appropriate after you have adequate savings. If you invest and lose money, you have sufficient savings to cover your needs. This will allow your investments to stay invested and hopefully recover any loss (and more!)
But say it out loud—INVESTMENTS TAKE TIME—No overnight guarantees.
What Do We Invest For?
We invest for a lot of things. Some more common than others.
- Invest for Retirement – This is the big one. Many of you likely have an IRA, a 401k, or some other retirement savings vehicle.
- Invest for College – College can be a bit of a hybrid between savings and investing. Depending on the time-frame, it can make sense to keep this money in savings, or it can make sense to put it in an investment.
- Invest for Investing – Often times I run into clients who have maxed out their retirement plans at work, they have adequate savings, and they still have “extra.” We help these clients establish tax-efficient investment accounts that are liquid, but long term in nature.
What Do Investments Look Like?
Investments can look like a lot of things. Your investment risk tolerance, your time horizon, your financial situation, and other factors will all play into how your investments will “look.” Some of the more common investment options are below.
- Individual Stocks – With an individual stock you are technically buying a share of the company. You are an owner (but keep in mind you likely own a small portion, so don’t start signing emails as the CEO). Buying a stock by nature is risky. You are taking the risk that the one company you purchased is going to do well. If it does, you win! If it doesn’t, you lose.
- Individual Bonds – This works similar to a CD at the bank. When you buy a bond, you are loaning money to a company, a government, a municipality, etc. In exchange, they will pay you an interest payment. The riskier the company, the higher interest you will earn (also the greater likelihood you will not get your money back).
- Mutual Funds – You’ve heard the word diversification, right? The story of don’t put all your eggs in one basket. When you buy a mutual fund, you are getting instant diversification.
- Exchange Traded Funds (ETF’s)- Exchange traded funds are slightly newer to the investment world. The act very similar to a mutual fund in terms of providing instant diversification.
- Other products – There are a number of different products out there that offer investment solutions… annuities, non-traded REITS, managed accounts, separate accounts, etc. Some of these can have a place in a portfolio, while others shouldn’t. But it’s important to know there are options.