What does it mean to invest money?
Investing, on the other hand, means you take your cash and use it to buy something you hope will increase in value. Usually, this means assets traded in financial markets like stocks, bonds, and mutual funds through accounts like IRAs, brokerages, or annuities— but it can also mean investing in real estate or even businesses or startups.
In most investments, you can't easily reclaim your cash. You need to sell the assets you bought, which could mean taking a loss if the assets are worth less at the time you need to sell them. This risk highlights a major difference between saving and investing: savings accounts are generally protected by FDIC insurance, meaning the money you contributed to the account is protected against loss up to $250,000 in a single account.1
By contrast, any investment comes with some degree of risk, meaning you risk not only losing a potential return but also losing a part or all of the money you initially contributed, called the principle of your investment. The more risk you take on, the higher the potential reward — but the greater chance you face of losing some of the money you invested.
Save for the short term and invest for the long-term
Because investing presents more risk, you might wonder why you would ever bother. After all, no one wants to lose money they worked hard to earn.
While savings accounts provide safety and liquidity, they don't provide returns like investing does. You may be able to earn some interest on your money, but there's very little potential for reward.
That matters because there are other powers at work here — namely, inflation. Savings accounts may provide you anywhere between 0% and 2% interest on your cash. But inflation runs, on average, at 2% to 3% per year.2 Over time, money sitting in a savings account earning less interest than the inflation in the economy will lose purchasing power.
That's not a big deal when you're talking about short-term goals or things you want to accomplish and pay for within the next five years. But when you are trying to meet long-term goals, like funding your retirement, this becomes a problem. Your money doesn't earn enough of a return in a savings account to allow you to meet such a big goal.
This is a powerful, exponential force that will better position you to achieve big goals and grow wealth over time. It only works, however, if you can invest and leave your money there to grow over the long term (think 10 years or more).
General rules for saving and investing
Here are the quick takeaways to remember when it comes to saving versus investing:
- Saving money is great for short-term goals (things you want to do in five years or less). For larger, longer-term goals (say, those that are 10 or more years away), consider investing.
- Saving money allows you to set aside cash with almost no risk of losing it. Investing presents a risk of loss but also the potential for higher rewards.
- Saving money provides you a way to access cash quickly, whereas investing should be for money you don't need to touch for a while. For example, your emergency fund should be in savings, while the nest egg you want to have for your retirement needs to be invested so it can be working for you, with the ultimate goal of growing over time through compound returns.
Both saving and investing money can help you meet your goals. Talking with a financial advisor can help you determine how much of your money should be set aside in savings, and what percent should be hard at work for you as an investment.