Savings vs Investments
If you suddenly receive a large sum of money and don’t impulsively spend it all, what should you do with it? Is it better to put it in a savings account or to invest it? What are the pros and cons of these options and when is it the right time to invest or save?
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What are Savings?
Saving is the act of moving money into a secured account where it can sit and grow over time, with the bank paying you interest for every year that it holds onto your money.
A savings account generally offers between 1% and 2% a year, which means you will receive $1 or $2 for every $100 that you save. You can open a savings account with just a few dollars and add money every money or simply begin with a large lump sum.
Are Savings Worth It?
The average savings account in the United States pays around 2% interest. This means a sum of $10,000 would generate just $200 after 12 months. $200 is not a huge sum of money, but it’s not to be scoffed at—if you’re a low-income household struggling with food bills, that $200 can come in handy and seem like a pretty big deal.
The problem is, if you’re a struggling household then you likely won’t have $10,000 sitting around and this is where savings accounts can seem a little pointless. It’s all relative–$2,000 might be a lot of money, but not to the person who has $100,000 to drop into a savings account and then forget about it. Conversely, while the average person can afford to put $1,000 in a savings account, they won’t be very impressed with the $20 it earns them over the course of a year.
So, what’s the point?
The important thing to consider here is that it isn’t all about the profit. It’s about using that money for good and getting something out of it after a few years.
As an example, let’s imagine that you smoke or drink heavily. You spend $100 a week on that activity, and it does you no good. You decide to stop and move all that money into a savings account.
You’re no richer or poor than you were as you still don’t have that money in your bank pocket, but you’re healthier and you’re building towards something good. You also know that you can’t simply waste that money on another vice, as you don’t have easy access to it.
After 5 years, that disposable income has grown to $24,000 and has earned an extra $1,250 in interest. Continue for another 5 years at the same rate, and you’ll have over $53,000. Do it for 30 years and you’ll have close to $200,000, over $50,000 of which is interest.
You now have enough money to buy your house outright, assuming you haven’t already cleared the mortgage; pay for your child or grandchild to go through medical school or leave a sizeable fund for your heirs.
Of course, 30 years is a long time for anything, but the point remains: It’s not necessarily about the interest, that’s just an added bonus. Think of your savings account as a virtual piggy bank, something you throw money into whenever you have some spare and then forget about, only checking it when you really need it.
When is Saving a Good Idea?
Savings accounts can benefit you in most situations and it’s never a bad idea to create one or two and start putting your money aside. However, one of the best uses of a savings account is for an unspecified emergency fund.
It doesn’t matter how rich and comfortable you are right now, that can change in an instant. You could be hit with medical bills, lose your job or experience some other kind of financial hardship. This can happen to everyone and the ones who are most oblivious about the potential damage such a situation can cause are the ones most susceptible to it.
If you’re frugal and budget very carefully, there’s a good chance you can find your way out of a difficult financial situation. If you’re used to spending freely and not concerning yourself with where your next meal comes from, you may find yourself in deep water very quickly.
What happens to your $10,000 a month expenses when you’re not earning $30,000 or $40,000 anymore? In the space of just a few months you could lose everything and find yourself in dangerous levels of debt. That’s why it’s important to put as much money as you can into a savings account.
Not only will it earn you a passive income, but it will help you in your time of need and potentially give you some time to get back on your feet or change your lifestyle to a more frugal one.
When is Saving a Bad Idea?
While savings are a great idea for someone with a lot of disposable income, they’re a bad idea for someone with masses of debt. You’re just throwing money down the drain, because even the most generous of savings accounts won’t earn you more than your debts cost you.
Let’s assume that you have $10,000 worth of debt on a 20% APR credit card and you just receive $10,000 from an inheritance. If you put it in a savings account, you’ll earn $200 a year and build an emergency fund. However, that credit card will cost you over $2,000 in the same time.
Your savings will never outpace your debt, so focus on clearing the debt first and then start building your emergency fund.
What is Investing?
Investing is the act of moving your cash into something that holds its value and, potentially, appreciates over time. There are many ways to invest, including:
- Collectibles: Any item that has a strong value now and is expected to hold that value and/or increase, including first edition books, rare coins, and anything produced as a limited edition.
- Precious Metals: Gold and silver are the most common, but investors also sink their money into everything from copper to platinum, the value of which fluctuates hourly but remains relatively stable from one day to the next.
- Stocks and Shares: Stock is, in essence, a part ownership of a listed company and may pay dividends every year.
- Real Estate: Historically one of the best ways to invest because while house prices fluctuate, they also experience growth in the long-term.
Is Investing Worth It?
Investing is a great idea, providing you know what you’re doing. The stock market is a perfect example of this. Not only can you purchase company stock that may increase in value, but you can also receive dividends that should earn you much more than a savings account ever could.
However, this industry is littered with wannabee traders who hear about people making millions, think they can do it themselves, and then lose everything on a volatile investment. If you don’t know what you’re doing, you either shouldn’t be doing it or you should be playing it safe, investing in a blue-chip company that will remain stable as opposed to a penny stock that could go bust.
It’s a similar story with collectibles. Countless people have read stories of comic books, first-edition books and original art that have sold for small fortunes, only to rush out and try to make similar investments themselves. The industry prepares for this, creating limited editions that are limited in name only, collectibles that have no collectible value, and items that are printed in such huge numbers they could never be worth anything.
To make any form of investing work, you need to know what you’re doing. If you do, you could generate much more than you ever could from a savings account. If you don’t, you could lose it all in a heartbeat.
When is Investing a Good Idea?
Extensive knowledge is nearly always an important prerequisite when it comes to investing, as is having a savings account to back you up and no debt to hang over you. But there is one exception, one where you don’t really need to be an expert and should invest even if you have a little debt and no savings: Real estate.
Real estate is one of the best investments you can make as it generally appreciates over time and will ensure that your investment remains safe. This is true even with a substantial mortgage, providing you have the funds to repay it over time and are not agreeing to an excessive interest rate or acquiring multiple properties with multiple mortgages.
When is Investing a Bad Idea?
If you don’t have any high-interest debt, have squirreled some money away for a rainy day and have some level of expertise in a particular field of investment, it’s a good idea. If not, it’s very risky. Don’t sink all the money you have into an investment, especially if you don’t really know what you’re investing in and are simply taking advice from a friend.
Expertise is key and could be the deciding factor that determines whether savings or investments are right for you.
Summary: Saving vs Investing
A good portfolio should contain both savings and investments and they should be used in similar ways. Inexperienced investors often invest more money than they can afford, even acquiring additional debt to do so. They hear stories about rich investors making it big online and they think they can do it themselves.
This is a terrible way to invest if you don’t have the experience and knowledge needed to make it happen, and if you believe that investing can make you very rich in a very short space of time, there’s a good chance you don’t have that knowledge.
Both savings and investments are designed to protect your money and reward you with small profits. They help you build for the future; they don’t make you rich in the present. Save, prepare, and focus on the long-term.