When Is It Better to Save or Invest Your Money?
Saving or investing? Both options require money you aren’t using to pay your immediate bills, and both can be used to reach financial goals and build wealth. But which one should you be focused on right now? Well, the answer depends on your current financial situation and your upcoming financial goals.
Knowing when to save, when to invest, and how much of each to do will be a key part of your plan for financial independence.
Saving should be an automatic part of your monthly budget. You need to have a healthy emergency savings available in an instant-access savings account—which just means an account where you can withdraw funds when you need them without paying a penalty. Ideally, you should shoot for between six weeks and three months’ worth of living expenses saved. If you have children, are the only income provider for your family, and/or own a house, you’ll want more saved than if you’re single and renting.
As your living expenses change throughout life, be sure to adjust your emergency fund target.
Once you have an emergency fund established, many financial advisors recommend saving at least 10% of your earnings each month (or as close to that amount as you can afford) for short-term savings goals. More on that later.
If you have high-interest debts to pay off, start by saving $1,000 and then put as much money as you can, after paying for essential living expenses, toward paying of your debt. Once you’re debt free (with the exception of a mortgage), then set your sights on growing your emergency fund.
Savings are great for unexpected bills, loss of employment, and short-term financial goals, like saving for a vacation. For all of those situations, the money should be kept in an account with easy access. The downside to these basic savings accounts is that they often do not provide enough earned interest to keep up with inflation, so your money could lose purchasing power over time.
To combat this, consider having some money in a basic savings account and some in a high-yield account or CD/share certificate. These accounts will offer better interest rates, but they will limit access to your funds for a set period of time.
Investing uses money you don’t need for living expenses or saving and puts it into financial tools like stocks, bonds, mutual funds, or other investment vehicles to build long-term wealth. Your rate of return can be much higher on investments if you’re willing to wait out fluctuations in the market. However, there is also a chance that you will lose money through investments, which is why it’s very important not to invest your savings but keep those funds separate.
Most financial advisers recommend you wait to start investing until you pay off the majority of your debt (again, your mortgage is usually an exception to this rule).
Save or invest — what’s best for your goals
The best way to determine if saving or investing will help you reach a financial goal is to look at its timeframe: short-, medium, or long-term. Below is a list to help you decide what’s the best move for you and your goals right now.
Short-term goals — the next 5 years. The general rule is to save money in cash deposits (i.e. instant-access savings accounts) for short-term goals that you want or need to reach within five years. The stock market is going to fluctuate in this time and your investments might take a loss before you need the money.
Medium-term goals — the next 5 to 10 years. Cash deposits could be the answer here—it really depends on the amount of risk you’re willing to take. If you have some flexibility on your goal deadline or the amount you need to save, you could invest. But, if you don’t have his flexibility, then saving is the route to go. Keep in mind that over 5 to 10 years, inflation will lessen the buying power of the money you save. So, if you decide to save, plan on saving a little more than you think you might need to make up for that loss or rotate the money through CDs/share certificates that will earn you more interest.
Longer-term goals — 10 years or longer. Ten years is really the tipping point that pushes in favor of investing. Stock market investments tend to do better than cash over ten years or more and give greater returns. To account for the inherent risk of investments, spread your money across different types of investments. This is called diversification.