With current interest rates on savings accounts hitting 4% or higher, the question between saving or investing is challenging for many individuals. When managing your money, saving vs. investing is one of the most critical decisions. While the two may seem interchangeable, they’re quite different regarding their purpose and potential benefits.
Savings, for example, are funds you set aside gradually, usually in a bank account, often for specific short-term goals like buying a car, making a down payment on a house, or covering unexpected emergencies.
On the other hand, investing is using your money to purchase assets like stocks, property, or mutual funds to increase their value over time.
However, as savings rates hit new highs, the distinction between saving and investing becomes blurrier. Let’s explore the fundamental differences and goals of an investor to determine the best choice for you.
The Concept of Savings
The concept of savings refers to deferring consumption and setting aside money or assets for future use. This can be accomplished through different means, including deposit accounts, pension accounts, investment funds, CDs, or simply holding cash. Saving in personal finance typically entails low-risk money preservation, whereas investing entails taking on higher levels of risk in exchange for a higher return.
It is important to note that saving is not the same as savings. Saving refers to an ongoing process of not consuming one’s assets, while savings refers to the assets, whether in cash or other conservative holdings, which do not risk the principal.
This distinction can be subtle but is important to understand, as it can affect how we think about our financial goals and strategies.
Types of Savings
Several forms of typical conservative savings are meant for different purposes.
- Regular Savings Account: This is a basic account that most people use to save money. Banks and credit unions usually offer it, and it is a simple and accessible way to save. The interest rate on regular savings accounts is typically low, but they are FDIC-insured up to $250,000.
- High-Yield Savings Account: This type of savings account offers a higher interest rate than a regular one. Online banks or credit unions typically offer these accounts, and the interest rates vary significantly. While they offer a higher interest rate, they may have more restrictions than a regular savings account.
- Certificate of Deposits (CDs): This type of savings instrument often allows a saver to lock in slightly higher interest rates by sacrificing liquidity. CDs generally lock in the investment period from between several months to several years, and it is imperative that an investor does not “break” the holding period, or else they owe significant penalties.
- Money Market Accounts: This type of savings account pays a higher interest rate than a regular one. They typically require a higher minimum balance and may restrict the number of withdrawals per month. Money market accounts are also FDIC-insured up to $250,000.
The Concept of Investments
Investments are a crucial aspect of personal finance and can offer a path to achieving financial goals. The primary objective of an investment is to generate income or appreciation over time. Appreciation is the increase or growth in the value of an asset over a specific time frame.
When investing, the intent is not to consume the good but to use it in the future to create wealth.
Investing involves putting capital to work in the form of time, effort, money, or an asset with the hope of a greater payoff in the future than the initial outlay. This means an investor may purchase a monetary asset to generate income or sell it at a higher price for a profit.
Types of Investments
The following are some forms of common investments.
- Stocks: They represent ownership in a company and are bought and sold on stock exchanges. Stocks can provide higher returns but also come with higher risks due to market volatility.
- Bonds: These are debt securities issued by companies, municipalities, or federal governments. Bonds typically offer a fixed rate of return and are considered low-risk investments, especially U.S. Government Bonds.
- Real Estate: Real estate investments can include residential or commercial rental properties, which often return income in the form of rent or lease payments. Other types of real estate investments include Real Estate Investment Trusts (REITs), which are professionally managed funds without requiring the investor to buy specific properties themselves.
- Mutual Funds or ETFs: Mutual funds and ETFs pool money from multiple investors to buy stocks, bonds, or other securities. These funds offer diversification and professional management, but they also charge fees. Often they track specific indexes and offer low management fees in exchange for diversification in a basket of securities.
Differences Between Savings and Investments
While they may be similar, there are some key differences between them. Below are some differences between savings and investments:
- Purpose: Savings are generally set aside for short-term goals or emergencies, while investments are typically made for long-term growth. Savings accounts are often used to hold money for expenses such as rent, bills, and other immediate needs. In contrast, investments are designed to generate returns over a longer period.
- Risk: Savings accounts are generally considered low-risk, as they are FDIC-insured and earn a fixed interest rate. On the other hand, investments come with varying levels of risk, ranging from low-risk options like government bonds to higher-risk investments like stocks and real estate.
- Tax Implications: The tax implications of savings and investments can vary. Interest earned on savings accounts is subject to income tax, while capital gains on investments are subject to capital gains tax, which can often be much more beneficial. So if you are considering putting more in a high-yield savings account for the long term, remember to consider the net return, including taxes vs. potential returns in assets that are taxed at capital gains rates.
In conclusion, understanding the differences between savings and investments is crucial for making informed financial decisions. Savings are meant for short-term goals and emergencies and are typically low-risk with fixed interest rates.
On the other hand, investments are better suited for long-term growth and come with varying levels of risk. Still, their tax advantages are more favorable for compounding your money because you can avoid paying annual income tax, and you can grow your principal plus interest as long as you stay invested.
Josh is a financial expert with over 15 years of experience on Wall Street as a senior market strategist and trader. His career has spanned from working on the New York Stock Exchange floor to investment management and portfolio trading at Citibank, Chicago Trading Company, and Flow Traders.
Josh graduated from Cornell University with a degree from the Dyson School of Applied Economics & Management at the SC Johnson College of Business. He has held multiple professional licenses during his career, including FINRA Series 3, 7, 24, 55, Nasdaq OMX, Xetra & Eurex (German), and SIX (Swiss) trading licenses. Josh served as a senior trader and strategist, business partner, and head of futures in his former roles on Wall Street.
Josh's work and authoritative advice have appeared in major publications like Nasdaq, Forbes, The Sun, Yahoo! Finance, CBS News, Fortune, The Street, MSN Money, and Go Banking Rates. Josh currently holds areas of expertise in investing, wealth management, capital markets, taxes, real estate, cryptocurrencies, and personal finance.
Josh currently runs a wealth management business and investment firm. Additionally, he is the founder and CEO of Top Dollar, where he teaches others how to build 6-figure passive income with smart money strategies that he uses professionally.