Sometimes “saving” and “investing” are used interchangeably, but they’re two completely different concepts. And choosing one or the other can impact your long-term financial situation significantly.
What is saving?
Saving means simply putting aside part of your income. Instead of spending everything you earn, you set aside a certain amount to use later. There are different ways to save, but the most common is to put your money in a savings account in a bank. There is no risk to save—your money will be there whenever you want to withdraw it!.
However, it’s important to know that in 2021, the annual inflation rate is around 1.1% on average, but interest rates for savings accounts usually range from 0.75 to 2%. Essentially, this means that the interest you could earn on your savings may not compensate for ever increasing prices (or inflation!).
If your savings are intended to finance a short-term goal, such as taking a trip or buying a new car, annual inflation doesn’t pose much of a problem. It’s when it comes to long-term saving plans—financing the purchase of a condo, for example—that you might end up losing purchasing power.
What is investing?
To put it simply, investing means acquiring assets (stocks, bonds, property, real estate, etc) that have the potential to increase in value over time. In this case, the point is to get a return on your investment. The money deposited in a savings account earns very little, while a smartinvestment allows you to grow your money much faster. Of course, the amount an investment earns during a specific time period (or yield rate) will vary depending on the type of investment, and there is also a risk that your investment may not see any returns.
What’s the fundamental difference between the two?
From a strictly economic point of view, saving is simply the money you don’t spend. The money you save is also liquid, meaning it’s available immediately.
Investing, on the other hand, is about using your money to generate a profit. Usually this is done with a long-term plan in mind.
Saving can be seen as a safety net that can be used to deal with the unexpected expenses that arise in life. If your car might break down or you owe money on your tax return, your savings can help you stay out of debt. A good rule of thumb for emergency savings? Aim to have the equivalent of 3 to 6 months of expenses set aside, so you can cover rent, groceries, utilities and all the other basics even if you suddenly lose your income.
If saving is a safety cushion, investing is the entire couch. Money that’s invested in the medium- and long-term is what generates a profit and can make it possible to improve your quality of life and set you up for retirement.
Making the choice between saving and investing is a question of your needs and personal preference. Your goals, risk tolerance, age and financial situation, such as whether or not you’re in debt, can help inform your choice. Getting advice from a financial advisor will help you make cents of your situation. What’s certain is that it’s never too early (or too late!) to start investing.
Give me an example!
Take Peter and Chloe: they each have the same profession and earn a salary of $40,000 dollars a year. Every year, Peter and Chloe both save 20% of their salary, or $8,000.. While Peter puts his money in a savings account, Chloe invests her savings.. Peter’s savings account earns 1% per year, while Chloe’s portfolio earns 5%. What happens after 40 years of working? Chloe will (potentially) have accumulated $694,718 in compound interest, while Peter will have only accumulated $75,001.90, even though he is earning the same salary and putting exactly the same amount aside!
It really makes you think, doesn’t it?