It will take more than savings to provide the retirement lifestyle of your dreams. To some, saving and investing might be interchangeable terms. Relatively speaking, savings offer lower risk and easier accessibility to funds than investments, while investments offer a potentially higher rate of return and a greater ability to stay ahead of the inflationary curve than savings. Funding your future optimally involves savings and investments, and not understanding the two can mean the difference between retiring with a steady money stream or living month to month on a strict budget.
A savings account generally represents the money you put aside a little at a time, typically into a bank account that earns interest, and investing generally represents purchasing assets (stocks, bonds, mutual funds, real estate) that also earn interest to grow your investment
Exploring Relative Risk Levels
Typically, saving accounts have little risk of monetary loss. If your financial institution is a member of the Federal Deposit Insurance Corp., your account is insured against losses up to $250,000, depending on the type of account and its ownership. FDIC-insured accounts normally include certificates of deposit, savings accounts and, depending on the bank, some money market accounts. Investments vary in their level of risk, but it is important to remember that some investment platform will expose you to the possibility of losing not only any earnings but the money you used to buy into the investment as well.
Assessing Availability of Funds
You can generally access money in savings quickly. USAA Financial Planning Services Insurance Agency Inc. states that most people use savings as an emergency fund or to accumulate money for a future purchase. Most high-return investments such as stocks provide their greatest yield when left alone for a long time.
While you can cash in investments, it typically requires more effort than removing money from a savings account and, depending on your age and the investment, you might face penalties on early withdrawals.
Comparing Return Rates
While the risk of losing money is higher on investments, so is the potential return. For example, a $100 stock market investment in 1945 had the potential to return $198,906 if left alone until 2011. That same $100 in a savings account would have netted the account holder $1,969. According to the Federal Trade Commission, be wary of investment opportunities that promise too much. Investments typically have no guarantee. However, you should be able to see profit projections provided by independent sources that will assist you when making an investment decision.
Evaluating the Impact of Inflation
The interest paid on savings accounts normally does not keep pace with the inflation rate, which means that in the long term, you are losing money. For example, if your savings account pays 1.5 percent interest and the rate of inflation in 2.75 percent, it is costing you money to keep the account. While investment return is not guaranteed, long-term stock gain has traditionally been about 10 percent annually, where "long term" typically means assets you hold for a year or more. Inflation reduces returns on long-term investments typically by a little more than 3 percent each year, but because of their higher return, they do not lose as much value as savings accounts.
Understanding Fund Types
Keep an emergency fund in a savings account where you have access to it quickly. CDs pay a higher interest rate than savings accounts but, depending on the terms, prevent penalty-free withdrawals until maturity. Money market accounts pay higher interest than savings accounts and provide access to some of your funds, but most accounts require a minimum balance.
Loans you make to a government or corporation through the purchase of bonds are typically long-term investments — five years or more — that either pay interest at maturity or specified dates throughout their life span. Mutual funds lessen your risk by combining your money with other investors to purchase a diverse set of stocks and bonds. Purchasing stocks gives you ownership in a company; your investment's return depends on how well the company does financially.
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