It’s a good thing to have some savings. When you put the money in a low-risk account, you can be pretty sure it will be readily available when you need it. Nonetheless, “saving” is not “investing” — and knowing the difference could pay off for you far into the future.
Think about it this way: Saving is for today, while investing is for tomorrow.
You need your savings to pay for your daily expenses, such as groceries, and your monthly bills — mortgage, utilities, and so on. In fact, you might even want your savings to include an emergency fund containing six to 12 months’ worth of living expenses to pay for unexpected costs, such as a new furnace or a major car repair.
These are all “here and now” expenses — and you could use your savings to pay for them. But in thinking of your long-term goals, such as post-secondary education for your children and a comfortable retirement for yourself, most individuals typically can’t simply rely on their savings — they’ll need to invest. Why? Because, quite simply, investments can grow — and you will need this growth potential to help achieve your objectives.
To illustrate the difference between saving and investing, let’s do a quick comparison. Suppose you put $550 per month into a savings account that paid hypothetical 2% interest. After 35 years, you would have accumulated about $330,000. Now, suppose you put that same $550 per month in a diversified investment portfolio that hypothetically earned an average of 6% a year. At the end of 35 years, you would end up with about $785,000. (These Hypothetical examples are for illustrative purposes only and do not reflect the performance of a specific investment. They also do not not include any transaction costs or fees.)
This enormous disparity between the amounts accumulated in the two examples clearly shows the potential difference between “saving” and “investing.” Still, you might be thinking that investing is risky, while savings accounts carry much less risk. And it is certainly true that investing does involve risks — investments can lose value, and there’s no guarantee that losses will be recovered.
Nonetheless, if you put all your money in savings, you may actually incur an even bigger risk — the risk of not achieving your financial goals. In fact, a low-rate savings account might not even keep up with inflation, which means that, over time, you will lose purchasing power.
Ultimately, the question isn’t whether you should save or invest — you need to do both. But you do need to decide how much of your financial resources to devote toward savings and how much toward investments. By paying close attention to your cash flow, you should be able to get a good idea of the best savings and investment mix for your particular situation. For example, if you find yourself constantly dipping into your long-term investments to pay for short-term needs, you probably don’t have enough money in savings. On the other hand, if you consistently find yourself with large sums in your savings account even after you’ve paid all your bills, you might be “sitting” on too much cash — which means you should consider moving some of this money into investments with growth potential.
Saving and investing — that’s a winning combination.
Jodi Nastor, CFP
390 McNabb Street Unit 2