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Saving vs. Investing: Picking the Right Goal for the Perfect Budget

by iTHINK Financial | Apr 01, 2021

saving-investing-perfect-budgetSaving and investing are both key pillars of financial freedom. Saving is a safer option than investing as you have full control of your finances. You may earn a little more based on your savings interest rate, but you should never find fewer funds than you put in.

When it comes to saving vs. investing, the two questions you may be having are "should I save my money?" or "should I invest my money?” This choice depends on your current financial situation and your short-term and long-term goals.

It is possible to use both of these money management strategies at the same time. But you may need to focus more on one over the other, depending on your financial circumstances.

Please keep reading for our complete guide to saving and investing money and how to use each strategy to achieve your financial goals.

What Is Saving?

Saving money is the act of keeping funds in a secure place for a future purpose or emergency. Due to inflation, savings tend to lose their value over time. This loss of value is because savings rates are lower than inflation rates.

When saving, it is essential to do your research into the different savings channels. Choose an option that will keep your money safe. We suggest securing your money at a reputable financial institution as it’s the safest way to save money.

Besides security purposes, it is advisable to save your money at a reputable financial institution to earn interest. Banks and other financial institutions provide a small interest percentage on any funds kept with them. Internet banks and credit unions generally pay a higher interest rate than traditional banks.

What Is Investing?

Investing money is the act of putting your money to work for a higher interest rate than what you would get from a savings account. You can invest in a few different ways, such as:

  • Stock market
  • Mutual funds
  • Funding a business
  • Buying assets that appreciate (real estate, gold, silver, etc.)
  • Buying cryptocurrency

Investments have much higher interest rates than savings. With the higher returns you get from the investment, there are higher risks of losing your money. For instance, you may buy stocks in a company that goes bankrupt.

Over time, investment funds can beat inflation and grow bigger than savings funds. But investing is riskier option as your funds may end up at a loss depending on market events.

However, there are investment funds that work similarly to bank accounts. You deposit your funds in the account and can expect to earn a certain interest amount every year. But the amount of interest earned is not guaranteed, and you may even lose all your capital in some of the riskier investment funds.

Unlike savings accounts, investment funds are not FDIC insured, so when they go bust, you lose your money. Start by researching into the different investment funds and vehicles to try and cut risks when investing. Choose proven funds, stocks and investment schemes.

Benefits of Investing

Generally, you can expect to earn more interest from investments than savings. Savings are a strategy to accumulate enough money for a given goal, whereas investment is a strategy to increase your financial worth. Put things into perspective by comparing the two numerically.

If you put $5,000 in savings accounts with a 0.5% interest, it will be worth about $5807 in 30 years. The $807 you will earn in 30 years will not compensate for the inflation during that period. So, $5,000 in today's market is not worth the same amount it was 30 years ago.

But $5,000 in an investment account with 6% interest would be worth $28,717 in 30 years. That is a huge difference. If you do not need your funds for a year or more, it is much more profitable to put them in an investment fund than in a savings account.

Some people even live off the interest and dividends they get from their investment accounts. One drawback to investment funds is that they may have high management fees that eat into your profits. Mutual funds that track the stock market are generally the best funds to invest in when it comes to management fees.

They have some of the lowest charges in the market. Tracker funds generally have 0.25% investment fees compared to actively managed funds that can charge up to 1.8%.

When it comes to taxes, savings get taxed at regular income tax rates. Different types of investments have different tax rates, but in general, these get taxed less than income tax.

Should You Save or Invest?

Now that you know the difference between saving vs. investing, you may be wondering if you should be putting your funds in investment or savings accounts. This decision depends on your current financial position, budget, and financial goals. If you are in debt, then your focus may need to be on clearing any high-interest debts.

If you are living paycheck to paycheck, your focus should be on saving. An emergency fund is the first step to financial freedom as it allows you to take care of emergency expenses without going into debt. Also, having at least three months of expenses saved (preferably a year) gives you a buffer if you lose your job or source of income.

If you already have an emergency fund saved up on top of your disposable income, then investments should be your focus. At this stage, you may not need the spare funds for years. So, you can afford to tie them up in land or stocks and let them earn interest until your retirement.

Most investment funds cost a considerable amount of cash to buy. Stocks and bonds also have relatively high costs, with the better-performing stocks costing more. In case you don't have enough funds to invest in the channel you desire, you may need to save up first.

Making a Financial Choice

If you have a short-term goal such as buying a car or going on holiday, then saving is a better strategy. You can figure out the fixed amount you need and how long it would take you to collect the funds. With investments, you may project that you will earn a certain amount of interest in a certain amount of time.

But when the investment period ends, the actual amount you earn may end up being less than you projected. This loss of value would derail your plans to buy the item you needed. Using a savings account removes the risk of losing the money you need to achieve your short-term goal.

If you have long-term goals such as paying for your child’s college or saving for retirement, investments may be the better option. That is because investment funds can double over time due to compound interest. Over time, the difference in growth between savings and investment funds is vast. So, you cannot afford to leave funds in low-interest savings accounts for years.

But if you are very risk-averse and do not want to make any losses, using savings accounts will work better for you than investment accounts. Even so, know that saving money rather than investing is a risk because your money may lose value over time due to inflation.

How to Save Money

The first step to saving money is to know the reason why you want to save. Having a goal in mind will make it easier to stick to your budget to save your target amount each month. Once you know your savings goal, your next step is to choose the savings account to keep your money safe.

It is to your benefit to choose a savings account with the highest interest you can get, with the least amount of fees. Some high-interest savings accounts in the market can earn you up to 1.50% in interest. But when shopping around, read the fine print.

Some institutions advertise high savings rates for new joiners but after the introductory period, their rates go down to below market average. Other institutions require you to have a high minimum balance and limit the number of withdrawals you can make. So, take a holistic view when choosing a bank to partner with for your savings goals and go for a bank with a high-interest rate and excellent customer service.

Once you have chosen your bank, you now need to deposit funds into your account regularly. You can set up a direct debit from your current account to send a certain amount to your savings account on a particular day each month. You can also deposit the funds manually into your savings account.

Financial advisors generally recommend saving at least 10% of your net income. You can increase the percentage if you have more disposable income and more pressing goals. With time, you will see your nest egg growing if you are consistent with your deposits.

Types of Savings Accounts

There are several tools you can use to save money. The first is a savings bank account. You can find them in all retail banks and credit unions.

The next step up from savings accounts is money market accounts. Financial institutions also offer these types of accounts and often have a higher interest rate than regular savings accounts. But in return, the banks ask for a higher minimum deposit and place higher restrictions on withdrawals.

You can also save money by buying savings bonds from the government. They give a guaranteed rate of interest, and you can only cash them in after an agreed amount of time, usually between one to 20 years. Government bonds have very low-interest rates, so it may be more profitable to save in a high-interest rate savings account.

Finally, you can also buy a certificate of deposit (CD) from a bank. This type of account lets you keep your funds with the bank for a given amount of time without withdrawing them. CDs have higher interest rates than regular savings accounts, but if you withdraw your money before the agreed time, you will be subject to withdrawal fees and interest penalties.

How to Invest Money

Investing money can work the same way as savings. You would need to shop around for a suitable investment fund that matches your budget, risk desire and investment goals. The fund manager would first ask you what your investment goals are.

Someone that needs their funds in 5 years will have a different strategy from someone that wants to access their funds in 30 years when they retire. Those with short-term goals will likely choose lower-risk investments such as bonds, while those with more time can go for higher-risk investments such as stocks.

Ensure you analyze all the fees and costs that an investment vehicle has, as these may eat up all your profit. The most common types of fees are:

  • Administration and management fees
  • Platform fees
  • Performance fees
  • Entry and exit fees

When buying stocks, you may also have to pay brokerage fees. Beware of financial advice fees if you seek the counsel of a financial advisor.

How much should you invest? Again, this depends on your budget and circumstances. But a good place to start is 10% of your income. The key to remember when it comes to investments is that the higher the investment risk, the higher your reward.

Types of Investing

There are several tools and investment methods available in today's market. Some examples of investment vehicles are:

  • Stocks
  • Bonds
  • Investment funds
  • Bank products
  • Options
  • Annuities
  • Retirement funds
  • Initial coin offerings
  • Cryptocurrencies

It is always important to learn all you can about the vehicles you choose to invest your hard-earned money in.

Learn About Saving vs. Investing to Make the Best Financial Decisions

When choosing whether to save or invest, assess your current financial situation, budget and financial goals. If you currently do not have an emergency fund and can't afford to buy regular investment vehicles, then your focus might need to be on savings.

If you are putting aside money to use within a year, you are better off saving than investing. But investment funds are a better option if you have long-term goals such as retirement. You already have a hefty emergency fund and lots of disposable income, so you can afford to invest your excess funds.

If you are looking for more information on financial management and saving vs. investing for financial freedom, talk to our team or become a member of iTHINK Financial today.

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