I once worked with a client who was 38 years old, single, and making $100,000 in income. She had $9,000 in her savings account and $112,000 in her retirement account (401k), with a monthly contribution of 6% and a company match of 4%. She had recently paid off her student loan debt, which left her with an “additional” $800 at the end of each month.
She came to me with the same question many of my clients ask—should she save or invest her additional money? During our financial planning session to help her answer that question, we mapped out her financial goals and came up with the following:
Create a cash cushion of $15,000 in the next two years
- Current Cash Cushion = $9,000
Save an annual travel budget of $3,000 per year
- Current Travel Savings = $0
Save enough to retire at 65 with $60,000 per year until age 100
- Current retirement savings = $112,000
Key Takeaways
- What you need, when you need it, and how much you can afford to contribute all factor into the decision of whether to invest or save.
- Usually, you would choose to invest your money for long-term financial goals like retirement because you have a longer time frame to recover from stock market fluctuations.
- If the financial goal is short term, say five years or less, it’s usually smarter to park your money in a high yield savings account.
Define Your Targets to Refine Your Approach
Once we wrote out her financial goals, followed by the savings, investing and interest required to meet them, we discovered the answer to her question. If she wanted to reach her goals, this is what she would need to save and invest every month:
- $250 per month toward her cash cushion
- $250 per month toward her travel savings
- $525 per month in additional retirement savings, assuming:
- Annual average growth rate pre-retirement = 8%
- Annual average growth rate post-retirement = 6%
- Inflation = 3%
- Social security is taken at the full retirement age of 67 and the amount in today’s dollars is $2,630.
For this client, we approached the save vs. invest question by reviewing what she had now and calculating what she could add in the future. What would she end up with? Would that meet her goals by her deadlines?
Prioritizing Goals
Since the total monthly dollar amount required to meet her financial goals was greater than the $800 per month she now had available, my client had a choice to make. Did she want to save her $800 for travel, pad out her cash cushion, or invest more toward her retirement now that she could see the required monthly investment to meet each one?
This is why there’s no universal answer to the “save vs. invest” question. What you need, when you need it, and how much you can afford to contribute all factor into the equation. As a general guide, I advise my clients to examine a few key metrics to help determine whether they should save or invest their money based on their specific circumstances.
Long term vs. short term
Usually, you would choose to invest your money for long-term financial goals like retirement because you have a longer time frame to recover from stock market fluctuations. But if the financial goal is short-term—say, five years or less as it typically is for travel goals—it’s usually not a smart choice to invest your money. In such cases, you’re generally better off parking it in a high yield savings account since you wouldn’t have much time to recover from a major downturn. Obviously, this also is based on your own unique risk tolerance and your overall financial health.
That’s why, for this client, I suggested she save a portion of her extra income for her short-term goals and a cash cushion, while also still investing for her long-term retirement plan.
Pros and Cons of Investing and Saving
Investing: Longer time horizon allows for compounding interest, growing your money.
Saving: Your money is liquid, so you can access it without penalty whenever needed.
Saving: You aren’t subject to market volatility.
Investing: Markets inherently involve risk, and investments may decline.
Investing: You may face a penalty for withdrawing the money too soon.
Saving: You’ll miss out on market gains and a potentially notable amount of compound interest.
I created a quick checklist to help others make this decision, based on their own needs. Of course, it’s always best to work with your own qualified financial planner, who can help you with your overall financial plan and make sure you are making the best decisions for yourself, but this is a great start:
Save vs. Invest Checklist
- Do you have an adequate cash cushion that would cover three to six months of fixed expenses? If not, then start saving.
- Do you have other short-term goals requiring quick access to cash (like travel plans)? If so, start saving.
- Are you on track toward reaching your retirement goal by your desired age? If not, start investing.
- Do you understand the risks involved in investing this money for a long-term goal such as retirement? You may not be able to access it until age 59½ without taxes and a penalty, plus you’ll face volatility risk, etc. Are you comfortable waiting to access your money in order to take advantage of compounding? If so, you may want to start investing.
- Do you feel comfortable with your current split of saving and investing every month? Where does it feel like you’re falling short?
While this checklist won’t cover everything, it’s a great start toward envisioning the future you want, plotting out how to get there, and preparing for what it will cost you. As always, it’s smart to work with your own financial advisor to review your current financial status, future financial goals, and the exact plan for reaching them.
Is It Better to Save Money or to Invest?
That really depends on your risk tolerance, financial requirements, and when you need to access the money. Investing has the potential to generate much higher returns than savings accounts but that benefit comes with risk, especially over shorter time frames.
If you are saving up for a short-term goal and will need to withdraw the funds in the near future, you’re probably better off parking the money in a savings account. Conversely, if your goals are longer-term, you’ll generally find more satisfactory results can be obtained from investing.
Why Is Investing Money Riskier Than Saving Money?
Most bank and thrift savings accounts are insured up to $250,000 by the Federal Deposit Insurance Corporation (FDIC), meaning if the institution holding the funds goes bust you won’t be left empty-handed. Investing doesn’t work this way. When you invest money, there is generally no insurance. You are essentially chasing a higher payout in exchange for the risk that you may not get everything back.
Of course, not every investment is the same. Some offer higher potential returns and risk, while others are much less volatile, resulting in less chance of losing money and a lower potential payout. Generally, the higher the risk, the higher the potential reward.
How Much Should I Keep in Savings?
Opinions vary. Most experts recommend maintaining a cash cushion of anything from three to six months of expenses to play it safe. Everything might be rosy today. However, there’s always a chance that you could at some point lose your job or be hit with a big unexpected bill.
Source: https://www.investopedia.com/should-you-save-your-money-or-invest-it-depends-4692975?utm_campaign=quote-yahoo&utm_source=yahoo&utm_medium=referral&yptr=yahoo