It’s good to have savings. When you put money in a low-risk account, you can be pretty sure it will be available when you need it.
Still, “saving” is not “investing” — and knowing the difference could pay off far into the future.
Think about it this way: Saving is for today; investing is for tomorrow.
You need your savings to pay for daily expenses, such as groceries, and your monthly bills — the mortgage, utilities and so on. In fact, you might even want your savings to include an emergency fund containing six to 12 months of living expenses to pay for unexpected costs, such as a new furnace or major car repair.
These are all “here and now” expenses — and you could use your savings to pay for them. But for long-term goals, such as paying your children's college tuition and enjoying a comfortable retirement, most individuals typically can’t rely on their savings — they'll need to invest. That's because investments can grow — and you will need this growth potential to help achieve your objectives.
Suppose you put $200 per month into a savings account that pays 3 percent interest (which is actually higher than the rates typically being paid today). After 30 years, you would have accumulated about $106,000, assuming you were in the 25 percent federal tax bracket.
Now, suppose you put that same $200 per month in a tax-deferred investment that hypothetically earned 7 percent a year. At the end of 30 years, you would have about $243,000. (Keep in mind that you would have to pay taxes on withdrawals. Hypotheticals do not include transaction costs or fees.)
This disparity between the amounts accumulated in the two accounts shows the 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 involves risks. After all, investments can lose value, and there’s no guarantee that losses will be recovered.
Nonetheless, if you put all your money in savings, you’re actually incurring a bigger risk — the risk of not achieving your financial goals. In fact, a low-rate savings account might not keep up with inflation, which means, 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.
Joe Faulk is a financial adviser.