Savings vs. Investments — Do You Know the Difference?

It wasn’t until recently that I realized there was a difference between savings and investments. Of course, I knew that you invest money into the stock market, and that you deposit money into a savings account, but I hadn’t really thought things through beyond that. (I don’t think I’m alone in this either.)

In the simplest sense, the difference between savings and investments is that when you save money, you hope to keep all of it for a particular purpose. When you invest money, you hope to use that money to make even more money than what you put in.

You probably have an end goal in mind for investments too — such as retiring or building up wealth to leave to your children someday — but that goal is something that’s in the distant future.

Savings goals are usually more short term and specific: you want to build an emergency fund, take a trip, buy a house, etc.

The key differences between savings and investments though are the level of risk and potential return.

When you deposit money into an FDIC or NCUA insured account, generally the only risks to your money (so long as you stay below the insurance limits) are a total financial collapse of the economy and/or the risk of what it will buy in the future decreasing due to inflation. Other than those things, the money is pretty safe. But in return for that safety, you get paid little or no interest.

On the other hand, when you invest money you can lose every last dime. (However the likelihood of that happening varies depending on what you invest in.) The upside to investing money is that you hope to make a profit. The bigger the hoped-for profit, the bigger the potential risk. (Really big hoped-for profits moves you out of investing and into the realm of speculation or scams.)

Those factors are why the only money I invest is money I can afford to lose completely. If I had put my emergency fund into stocks in August of 2008 and needed to use it the next month, I would have been in trouble because a good chunk of it would have been gone. So I left my emergency fund in ING Direct, and bought stocks with other money instead. Of course I hoped to gain, but when my investing accounts dropped by 40% it wasn’t a critical issue. (Just depressing.)

The differences between savings and investing means that it’s important to know your objectives for the money, your real level of risk tolerance, and how much time you expect to have before you’ll need the money.

Once you know those things, you can start to look into the vehicles for saving and investing.