Do you know the difference between savings and investments? Of course, you invest money into the stock market or other things, and you deposit money into a savings account.
But there is in important difference beyond the terminology and where you put your money. Knowing and understanding what that is can have a huge impact on your money.
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 take a trip, buy a house, etc.
Of risk and return
The key differences between savings and investments though are the level of risk and potential return. In this case, risk is the chance that you will lose money, and potential return is the possibility that you will make money.
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.)
Striking a balance
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 alone, 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.) I still had the savings sitting there in case it ever needed to be used for its intended purpose.
Know your objectives
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. Then you can place a portion of your money toward each goal, and give yourself the best shot at long-term financial success.Posted in Savings on 02.13.13 with 6 comments.