Understanding the Differences Between Saving and Investing

$100 bills fanned out on top of white envelope

I recently came into a relatively large amount of money after we settled my mother’s estate. It wasn’t I can quit my job and retire to Tahiti money, but enough that over time it could make a difference in my lifestyle. However, with us looking to downsize I realized it would be smart to keep it liquid until we decided on a house. A side-benefit was that I didn’t go all-in on the markets earlier this year just as inflation hit, interest rates increased, and the markets declined.

If you similarly have some cash sitting on the sidelines and don’t have a plan (like buying a house soon) that determines where you should place your money, here are a few things to keep in mind.

How are saving and investing different?

All too often, investing and saving are used interchangeably. For instance, you might have heard someone say I’m saving for retirement. Let’s hope they mean investing for retirement, because it’s really hard for the majority of people to save at recent low rates and achieve a comfortable retirement.

Saving is all about liquidity – having access to your money without the worry of taking an investment loss. So think about checking or savings accounts, Treasury bills, and money market accounts. You can even stretch this to include CDs or I Bonds, but with those you don’t have immediate access to your money (although you may earn a little more than with accounts providing immediate access).

Investing is all about returns. Whether you are investing for a specific goal like a house or for retirement, you put money into stocks, bonds, real estate, and other investments for a longer period of time and hope for an increase in capital.

Note: Before I delve too deeply into this, I need to mention risk. There is no risk-free way to hold money. If you bury it in a can in your back yard or save in a low-interest account, inflation will eat away at the value of each dollar. If you invest it, down markets or company-specific troubles could reduce your portfolio. As you read through this, think about what you’re more comfortable with and how you best can sleep at night.

Time matters

Immediate. No matter how much money you have, one of the key considerations when determining where to place your money is how much time you have until you need it. In my case, I knew we might buy a home as soon as a few months after I received my portion of the estate, so keeping it readily accessible was a no-brainer.

  • Daily life: the money you need to pay your electric bill should be kept in a checking account or other account (savings, money market) from which you can pay bills. People often tie together their checking account and high-interest savings account. This allows them to earn a little more with savings and quickly move money into their checking account to pay bills and avoid low-balance penalties.
  • More than one year: Let’s say you’re me, but instead of looking at houses now you’re looking in a year. In this instance, you probably wouldn’t want to invest in the markets since there’s a good chance you could lose a significant portion of your money. Here you might want to save with a CD or Treasury I bond. Both may provide a little more interest (the I Bond a significant amount more) but neither allows for immediate withdrawals.

Long-term. With a very long-term goal like retirement, investing your contributions makes the most sense. You may not need that money for 40 years, and investments held over that time period have provided positive returns in the past (remember past performance is no guarantee of future results though). Consider investing in your retirement plan available through work, an IRA or Roth IRA, and potentially an after-tax brokerage account.

Three to seven years. When you are deciding what to do with money you’ll need in three to seven years, the decision isn’t as cut and dried. Some people are comfortable investing money they will need in three years; others will save money they won’t need for a decade or more. Most financial advisors recommend that if you will need the money within the next five years, you shouldn’t put it in the markets.

If you might need money in this time frame and don’t know what to do, take a look at your total financial picture:

  • Do you have an emergency fund that will cover at least six months of expenses? If so, you may feel more comfortable with riskier investments.
  • What other life events could occur that might require access to this money? Say you’re saving for a beach house, is there a chance you could become pregnant, or have to start taking care of your parents? If there’s a higher chance you’ll need the money that might lower your comfort with risk.
  • How are you at keeping your hands off your cash? I’m great at skipping dessert when there’s nothing in the house, but put chocolate anywhere and suddenly I have no willpower. How are you at resisting the lure of hundreds or thousands sitting in an account? Many people keep a separate non-connected savings account so it’s harder to retrieve their money. If you have a hard time saving, you might consider locking into a CD or I bond so you don’t think of the money as ready cash.
  • How do you feel about your current situation? If you have a large balance saved up for retirement, you might be comfortable letting your money sit in a savings account even for a decade. If you feel like you’ve started late and need to catch up, the siren song of riskier investments may be playing in your ear. It really is up to you and your comfort with risk.
Consider both saving and investing

Nowhere does it say that you have to only invest or only save. Perhaps you earned a promotion at work and suddenly have $1,500 extra every month – you could easily parcel out a portion for savings or to increase your emergency fund while also investing more for retirement and putting a little toward a second home. The key is to save enough where you won’t have to sell off investments in the majority of emergencies that could conceivably strike. There’s no way to cover everything, but you wouldn’t want to sell off a losing investment just because you need new tires.

Disclaimer

Leave a Reply

Your email address will not be published. Required fields are marked *