Subject: Financial Planning - Saving versus Investing
Last-Revised: 26 Mar 2006
Contributed-By: Quentin James
It is a common misconception that the terms "Saving" and "Investing" are synonymous with each other - the truth of the matter is that they are vastly different animals for vastly different purposes. Getting a hold of the difference between saving and investing is the key to managing your money. It will help you make more informed choices about financial requirements and needs and actually prevent the unnecessary loss of wealth.
Generally, "saving" can be best defined as a way of seeking to preserve the assets that you have built up over time. The problem is that most people don't realize that you can actually lose money in various conservative saving vehicles. This happens as a result of taxes and inflation.
When saving money, the primary emphasis is on the stability of the principal rather than return potential. Psychologically, the appealing feature of saving money is that you are given certain guarantees such as the fact that you're balance will never go below the principle and that you will get a steady, predictable interest rate. To most
Savers usually store money in low-volatility vehicles like bank savings and checking accounts, certificates of deposit (CDs) and bank money market accounts. The non-volatile nature of these options offer relatively low potentials for return but the overwhelming benefit for them is that the principal is kept safe while interests, however low, are pretty much guaranteed. For money that is needed in the short term, savings are probably the best option.
It is important to remember that this fairly small return potential may not even be able to keep up with the inflation rate and is still subject to taxes. This can actually result in a loss of overall purchasing power for your money, despite what appears to be a slight gain.
As the cost of living increases, you have no choice but to buy goods and services with more money. This happens because inflation results in a loss of value for your money and it makes the task of meeting your financial goals that much more difficult. This means the money pie you are dividing is getting smaller and smaller portions. Your money must be able to grow faster than inflation if you are to achieve your long-term financial objectives.
Investing is the key to meeting your long-term financial goals. The key ideas behind investing are production and growth. By investing, you are putting your money to work to produce goods and services that will in turn make profit.
To many, investing seems to involve greater risk to the principal compared to saving, and it does over the short time. Investing is less predictable and more volatile in the short run. However, it also offers greater monetary rewards in the form of higher return potential and an overall increase in purchasing power.
Most available investments like bonds, stocks, and mutual funds fluctuate in value. The reasons for this fluctuation vary. In the short terms, the fluctuations often reflect emotion and psychological reactions rather than the real value of the securities. Because of this, a key for common sense investing is to not be swayed by group-think.
Investors must be willing and able to tolerate the ups and downs of the market as well as fully understand that there is the possibility that they may lose the principal if their investments decline in value. However, such loss of principal can reliably be avoided by making wise decisions and the trade-off for short-term uncertainty is the possibility of much greater wealth. It also turns out that the risks involved in investing virtually disappear when doing a long term analysis. Indeed, the greater long-term risk may be with saving vehicles such as CDs and Savings Accounts. This is because historically, equity and bond investing has offered better inflation protection compared to low-risk savings instruments.
In other words: over long periods of time (greater than three years) there is good historical evidence that investing your money is less risky than saving it, when the single criteria is the purchasing power of your initial investment. Surprising, isn't it!
Should you invest your money or save it? The answer to this question will depend mainly on you and your goals. Determine your financial goals, how much you have accumulated and still need to fund your goals, your time frame and your comfort level, keeping in mind the difference between short and long-term risk. If you need your money within three years, then it is probably best to save it. But if you want to build wealth over the long-haul, the only real solution is to invest.
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