June 30, 2021

Savings vs Investing

Read more about Investing
This article contains references to products from our partners. We may receive compensation if you apply or shop through links in our content. You help support CreditDonkey by reading our website and using our links. (read more)

What are the rules of saving vs. investing? Find out how to prioritize your finances and how much you should save BEFORE investing.

Saving and investing are essential tools for personal finance.

But how much should you save vs. invest? And is one more important than the other?

In this article, find the answers to these important questions about saving and investing. Plus, learn how to allocate your cash between the two, and review their different risk and return profiles.

What's the Difference Between Saving vs. Investing?

Saving and investing both involve putting away your money today so you can use it sometime in the future.

The main differences between saving and investing are:

  1. The risk/return profile
  2. Liquidity
  3. The time horizon

When you add a dollar to your savings account, you can expect that dollar to be there until you decide to use it. Apart from a little interest, you know the amount will stay pretty much the same - no more and no less.

The point of saving is putting away money that is guaranteed to be there whenever you need it. Savings are more accessible (i.e., liquid) and offer less risk, but there's also no opportunity for it to increase in value.

Investing involves using your cash today to buy stocks, bonds, or other securities so it can (hopefully) increase in value over time. In short, investing is putting your money to work for you.

Your investments are less liquid and riskier than money in a savings account, but they have the opportunity to increase in value.

Is saving better than investing?
Neither one is "better" than the other. Saving and investing are both important in reaching different goals. Savings act as a safety net so you have the cash for both planned and unexpected expenses, and investing allows us to increase the value of our excess savings over time.

What are the Risks and Opportunities of Savings vs. Investing?

Saving
There is little risk in putting your money in a savings account at the bank. The biggest risk is inflation, which erodes the purchasing power of your dollars due to increasing consumer prices.

Inflation in the U.S. averages about 2% per year, which means the $100 you deposited at the beginning of the year will be the equivalent of having $98 to spend on goods at the end of the year.

There is also the slight risk of your bank failing, but as long as they are a member FDIC, the government protects your savings up to $250K per bank.

Overall, holding cash is relatively risk-free, but there are also no opportunities for your savings to significantly increase in value.

Investing
Investments offer plenty of opportunities to grow your money, but also come with the risk of losing some (or all) of it.

A diversified portfolio of stocks and bonds will earn roughly of 7% per year, but financial markets can be very volatile. There is no guarantee what your investment will be worth next year and beyond.

Another major risk is having to sell your investments if you need money quickly. In this case, you might be forced to sell at the wrong time and at a discounted price.

What are the rates of return for savings vs. investing?
In today's ultra-low interest rate environment, the average savings account will earn you 0.06% per year. Depending on how much risk you are willing to take with your investments, a diversified investment portfolio could earn you anywhere from 3%-12% or more per year over the long term.

Savings vs Investing Calculator

Pros and Cons of Savings

Pros

  • Very low risk - you won't lose money
  • Very liquid - your money is there when you need it
  • Easy and accessible - most savings accounts are free and easy to open

Cons

  • No gains (other than a tiny interest rate)
  • Loss of purchasing power due to inflation

Pros and Cons of Investing

Pros

  • Historically proven high returns over long term
  • Preserve purchasing power and build wealth
  • Relatively easy to invest (even for beginners)

Cons

  • Can be very high risk (depending on investment)
  • Illiquid (in some cases, money is "locked up" for years)

What Percentage of Your Savings Should You Invest in Stocks?

How much you should save vs. invest varies from person to person. Your "perfect" percentage depends on factors like:

  • Income
  • Age
  • Expenses
  • Life goals

As a general rule, most financial advisors recommend having enough savings to cover six to 12 months of your living expenses. This "cash stash" is important because it provides immediate liquidity for you to tap into under unexpected circumstances, like the sudden loss of a job.

Want an exact number for your emergency "cash stash"? Our calculator will crunch the numbers for you.

After you've built up enough savings, consider investing between 10%-20% of your monthly paycheck in stocks or similar investments. The exact percentage will vary depending on your income and your monthly expenses, but try to invest as much as reasonably can.

This works best if you don't need this money for a while (at least 5-10 years). While short-term stock market returns are impossible to predict due to volatility, over long enough periods of time, stocks have historically averaged 7%-10% annualized returns.

What is a Better Investment than a Savings Account?

Want to earn better returns than a traditional savings account but avoid market volatility? Luckily, you have some options. Here are a few different approaches to consider:

High Yield Savings Accounts
High yield savings accounts are almost identical to regular savings accounts but pay a better interest rate - generally around 0.4% to 0.5% at the current time.

The only minor drawback is that high yield savings accounts limit the number of monthly withdrawals you can make to six.

Certificate of Deposit (CDs)
CDs are another risk-free alternative to savings accounts. Depending on the maturity of the CD, they generally pay more than a high yield savings account.

The drawback is that you won't have access to the money until the CD matures.

Short-term Government Bonds
Another option is a short-term government bond, commonly referred to as Treasuries in the U.S. These offer similar returns as a CD.

The 10-year U.S. Treasury bond is currently yielding around 1.5%, and these can be easily invested in either directly or through an ETF. This is considered a risk-free investment.

Short-Term Corporate Bonds
If you like the liquidity of a government bond ETF but are willing to take on some risk for a better return, you may want to consider a short-term corporate bond ETF, such as the Vanguard Short-Term Corporate Bond ETF (VCSH).

Returns are generally around 3%-4%/year, and although corporations have credit risk, this ETF invests in short-term, investment-grade debt and where the default risk is very low.

Peer-to-Peer Lending
One less common alternative to a high yield savings account is investing in personal loans via peer-to-peer lending platforms like Lending Club. A well-diversified portfolio of personal loans can reliably be expected to return 6%-9%/yr.

Besides the risk of default, another drawback of peer-to-peer lending is that your money is tied up for the duration of the loan.

Looking for more short-term investments? This round-up of options offer good returns with fairly little risk.

How Much Money Should You Save Before Investing?

Before you dive head-first into investing, you should have a good amount of money saved and your debts under control. Here are three things to address before you invest:

  1. High-interest debt
    Earning a 7% return in the stock market is great, but it doesn't make a lot of sense if at the same time you're paying 20% interest on credit card debt. It's always a good idea to use extra funds to pay off expensive debt before starting to invest.

  2. Emergency fund
    As mentioned above, having an emergency fund to cover at least six months of expenses is also a smart move.

    You'd be surprised what unexpected costs might pop up. With an emergency fund in place, you can focus more on investing.

  3. Retirement account
    Make sure your retirement account is set up with regular contributions before investing through a taxable account.

    Besides the security of planning for retirement, IRAs and 401(k)s have unique tax advantages that make them a no-brainer for maximizing your wealth.

    Many employers will also offer to match some of your contributions to a retirement account. You should absolutely take advantage of this match because its essentially "free money."

Is it better to keep cash or invest?
You should build up a solid savings account first to fortify your financial security. After you've built up your savings cushion, investing extra money is a must for building wealth longer term.

Best Ways to Invest

Whether you're a hands-on investor looking to build a portfolio from scratch or a completely hands-off investor, there is a platform out there for you.

Hands-on Investors
For those who want to do in-depth research of companies or ETFs, consider full brokerages like Ameritrade or Fidelity.

These platforms are pretty robust and offer stock and fund screeners to thoroughly research potential investments.

Experienced investors might also try investing in real estate through crowdfunding sites like Streitwise or CrowdStreet. Real estate offers above-average returns compared to stocks with less volatility, but also less liquidity.

Hands-off Investors
Hands-off investors should focus on investing apps that have good robo-investing platforms, such as SoFi Invest.

Robo-investing involves the investor answering some basic questions about their risk appetite and investing goals, which it uses to build you a tailored portfolio of ETFs. This is the "set it and forget it" version of investing.

For more ideas on how to invest, plus how to identify the right investments for you, check out our guide.

Bottom Line: Should You Save or Invest?

To sum up this article - you should save and invest. Both are essential tools for fortifying your financial security and for preparing to achieve your goals for the future.

Building a savings buffer gives you the financial flexibility to handle tomorrow's surprises, whatever they may be.

And afterwards, investing 10%-20% of your paycheck in stocks or a diversified portfolio will build the wealth everybody hopes to be able to lean on in their golden years.

Write to Andrew Fitzgerald at feedback@creditdonkey.com. Follow us on Twitter and Facebook for our latest posts.

Note: This website is made possible through financial relationships with some of the products and services mentioned on this site. We may receive compensation if you shop through links in our content. You do not have to use our links, but you help support CreditDonkey if you do.

TD Ameritrade has not influenced the content of CreditDonkey. CreditDonkey may earn compensation for accounts opened at TD Ameritrade.

Read Next:

How to Invest Money: Make Money Work for You

How to Invest Money

Top 10 Best Online Savings Account

Best Online Savings Account

Best Robo Advisor

Best Robo Advisor

Savings Accounts vs CDs

Savings vs CDs

Best Investment Apps

Best Investment Apps

Checking vs Savings Account: What's the Difference?

Checking vs Savings Account

TD Ameritrade

Commission-Free Trading - Online Stock, ETF and Option Trades

Applies to U.S. exchange-listed stocks, ETFs, and options. A $0.65 per contract fee applies for options trades, with no exercise or assignment fees.

FIRE Calculator for Beginners

FIRE Calculator

How to Invest in ChainLink

How to Invest in ChainLink

How to Invest in Bitcoin

How to Invest in Bitcoin

Ledn Review

Ledn Review

Coinbase Pro Review

Coinbase Pro Review

Why Investing is Better than Savings

Why Investing is Better than Savings

Leave a comment about Savings vs Investing?



Best Places to Buy Bitcoin

Best Places to Buy Bitcoin

In the last decade, Bitcoin has gone from a niche digital currency to an economic powerhouse. Discover the best places to buy Bitcoin in this guide.

About CreditDonkey
CreditDonkey is a personal finance comparison website. We publish data-driven analysis to help you save money & make savvy decisions.

Editorial Note: Any opinions, analyses, reviews or recommendations expressed on this page are those of the author's alone, and have not been reviewed, approved or otherwise endorsed by any card issuer.

†Advertiser Disclosure: Many of the offers that appear on this site are from companies from which CreditDonkey receives compensation. This compensation may impact how and where products appear on this site (including, for example, the order in which they appear). CreditDonkey does not include all companies or all offers that may be available in the marketplace.

*See the card issuer's online application for details about terms and conditions. Reasonable efforts are made to maintain accurate information. However, all information is presented without warranty. When you click on the "Apply Now" button you can review the terms and conditions on the card issuer's website.

CreditDonkey does not know your individual circumstances and provides information for general educational purposes only. CreditDonkey is not a substitute for, and should not be used as, professional legal, credit or financial advice. You should consult your own professional advisors for such advice.

About Us | Reviews | Deals | Tips | Privacy | Do Not Sell My Info | Terms | Contact Us
(888) 483-4925 | 680 East Colorado Blvd, 2nd Floor | Pasadena, CA 91101
© 2021 CreditDonkey Inc. All Rights Reserved.