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This article was originally published on marcus.com.
Saving is generally predictable and safe—you know exactly where your money is (in a savings account, money market fund or certificate of deposit) and how much interest it’s earning (at a given rate). And if you open a savings account that’s FDIC-insured, your deposits are protected up to a certain amount.
Let’s look at an example of how money in a savings account grows. Interest rates have fluctuated over the past several years, peaking at 2.15% in 2019. Say you put $10,000 into a high-yield savings account earning 0.5% interest. Assuming you keep that full amount in your account and the rate remains unchanged, in five years, you’ll have earned over $250 in interest.
If Ayco is offered through your employer, speak with a coach to discuss different types of savings vehicles that may be available to you.
When you invest, you’re putting money into a vehicle—often the stock market—with the expectation that it will generate more money over time. Common types of investments include stocks, bonds, mutual funds, index funds and exchange traded funds (ETFs).
Investing money involves risk and uncertainty. Investments can be volatile, which means they fluctuate in price—sometimes they lose money and sometimes they make money. Unlike a savings account with a fixed rate, returns on investments can vary over time.
Historically, investing in the stock market has generated higher returns, but nothing is guaranteed. Typically, higher returns are a result of investing in vehicles with a higher risk level. For example, one would expect to receive a higher return from investing in technology stocks than from investing in U.S. Treasury bonds. To learn more about the potential risks and rewards involved with different investment types, check out our article “What is risk tolerance and how does it impact my portfolio?”.
The key difference is this: When you save money, you’re putting your money somewhere safe to use for the future, often for short-term goals. Alternatively, when you invest money, you accept a greater potential risk in return for a greater potential reward. Investing often makes more sense for long-term goals.
So when is it better to save versus invest? The answer depends on your financial goals, how much time you have to meet those goals and how much risk you’re willing to take. Generally, depending on your goals and their time frames, you’ll both save and invest. An Ayco coach can help you understand the best strategies for your personal situation.
Investing can be used to meet long-term financial goals, like planning for retirement or paying for a child’s education. The further out your intended use of the funds is, the more investing makes sense. The longer you leave your money invested, the more time it has to grow (with some help from compounding earnings), typically with a higher return than what a savings account will offer, and the more time your investment has to recover from any downturns.
There’s a world of information available if you’re looking to learn more, but for most people, investing doesn’t need to be complicated. Here’s how to keep it simple:
The investment of your retirement accounts—401(k), IRA or other retirement savings accounts—will generally change over time. Early on in your working life, you may invest in higher risk vehicles, like stocks because you could see higher returns and you have time before you’ll need the funds. As you get closer to retiring, you may adjust your investing strategy to make it more conservative—like by investing in bonds—as you’ll need the money sooner and may not be able to weather potential losses. Of course, your investment strategy depends heavily on your personal preferences around risk, so you may choose to invest in more conservative vehicles earlier or riskier vehicles later.
Retirement plans might even offer “target date funds,” which are often a series of mutual funds that allow you to choose a fund with a target date close to your anticipated retirement (e.g., 2055 target date fund). Target date funds automatically adjust to be more conservative as you get closer to the target date. This could be a great option if you’re looking to automate your finances and don’t want to get in the weeds of adjusting your portfolio.
A note about 401(k)s: Some companies offer an employer match, meaning for every contribution you make up to certain point, they will also make a contribution. The details of employer matches can vary, so check with your employer. If your company offers this benefit and you can afford to—take advantage of it. It’s a great way to boost your savings and make progress on your retirement goals. For more information on 401(k)s and other retirement savings accounts, we’ve created a guide to walk you through common considerations.
Generally, both saving and investing will be part of your overall financial strategy and are happening at the same time. For example, you’re contributing to your retirement plan while also saving for your honeymoon. If you’re new to both, you probably want to start with building your savings and contributing as much as you can to retirement.
Want a good way to learn about saving and investing money? Put your money to work by opening a savings account, contributing to your retirement account, and then paying attention to what your money does. You’ll probably learn a few things just by doing and observing. If that sounds too time-consuming, it’s completely fine to keep it simple. Make a plan to automate your contributions, revisit that plan occasionally and adjust accordingly.
No matter your style, just remember the key takeaways:
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Updated for tax year 2020