The Difference Between Saving and Investing

All of us want to grow our hard earned money. So at early age we were taught that the only way is to open a savings account and save everything in the savings because it will grow. However, as finance continue to progress, this advice no longer applies. For one, the interest rates are so low and the rate of return is so minuscule that it defeats the purpose of saving money in a savings account.

Don’t get me wrong. Saving money in a savings account has its benefit too. For example, it is usually the source where you can use to pay for your daily expense or your “rainy day” funds. What you should not do is to use your savings account as your retirement income. Another other option to grow your money is to put the money in an investment account. History facts indicate that the money in investment account grow at a faster rate that what you have in the savings.

I’m not going to defend one over the other because both have its pros and cons. The better strategy is to have both. The question is how much you put in both. There is no right or wrong answer because it depends on personal lifestyle and your current condition. For example, if you are now in dire situation where you may not be able to afford food on the table, putting money in the a investment account is not advisable. However, if you have sufficiently money saved to last 6 months should you lose your job, then you should consider move some of the funds to an investment account.

Risk

Investing in stocks (or any financial instruments) carry a higher risks than saving your money in a savings account. The major risk is a potential loss in value. On the other hand, the money you save in savings account will not lose value unless there is hyper-inflation in the economy. While the risks in investment exist, the pros sometime may surpass the cons. The best strategy is to invest only the money that you are willing to loose. You should never borrow money to invest and never invest your entire life savings in any investment account.

Rate of Return

Banks usually guarantee a return on the money you save in the savings account. These are called interests. However, the rate of return depends on the interest rate controlled by the Federal Reserve Bank. The interest rate today is at 0% because the Fed is trying to stimulate the economy by making borrowing money cheaper. On the flip side banks are offering less interests for existing savings account and that means the rate of return for the money you save is also less.

The rate of return on investments continue to on an upward trend despite the negative trend on the economy. As an example, a $6,000 dollars that I invested in a traditional IRA account in early March has a balance of $6,400 today (early June). Assuming that there rate of return is the same for the remainder of the year, that is equal to almost 20%.

Liquidity

Money saved in a savings account is considered a liquid asset. That means that it can be easily changed into cash and be used immediately. Depends on the type of investments, some assets are not easily converted into liquid asset. Examples such as retirement accounts (i.e. 401K and IRAs). Withdrawing money from these accounts could involve penalties and high tax rate. Money invested in stocks can be converted to cash but usually take several days depends on the banks or brokerage firms. If you are in an emergency, it could mean life or death.

It is important that everyone of us should consider these factors and understand one’s financial condition to determine what is the right mix when it comes to putting money in savings account and investment account. Both accounts have pros and cons. If you are interested in growing your hard earned money, putting the money in investment accounts is a “no brainer”. However, if you want to have a peace of mind and willing to forgo the potential income that investment accounts may bring, savings account is your only choice.

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