What will happen when you are no longer working? If you make an income, chances are you’ve thought about retirement. Are you prepared? Hopefully you’ve put some thought into planning long-term through either investing or saving.
The next several weeks, I will be delving deeper into these subjects, giving my thoughts and opinions on the best ways to invest and/or save for the future. Many people think the two are synonymous, but today I’ll give an overview of the basics of each and how they differ. (Disclaimer: I’m not a licensed investor and in no way am I suggesting what to do with your money. I simply want to give you scenarios of what seems to be the successful trend over time concerning saving and investing and to express the critical nature of learning how to do both.)
The U.S Securities and Exchange Commission explains the difference between investments and savings this way:
Your “savings” are usually put into the safest places or products that allow you access to your money at any time. Examples include savings accounts, checking accounts, and certificates of deposit. At some banks and savings and loan associations your deposits may be insured by the Federal Deposit Insurance Corporation (FDIC). But there's a tradeoff for the security and ready availability of these savings methods: your money is paid a low wage as it works for you.
When you "invest," you have a greater chance of losing your money than when you "save." Unlike FDIC-insured deposits, the money you invest in securities, mutual funds, and other similar investments is not federally insured. You could lose your "principal," which is the amount you've invested. That’s true even if you purchase your investments through a bank. But when you invest, you also have the opportunity to earn more money than when you save. There is a tradeoff between the higher risk of investing and the potential for greater rewards.”
In reading that explanation, it’s clear there is value in both saving and investing, so it’s ideal to be doing both.
Savings: It’s important to have a liquid savings in place, meaning readily accessible. Dave Ramsey, author, businessman and motivational speaker, calls this an “emergency fund”. Money magazine predicted that 78% of us will experience a major negative financial event in any given 10-year period. How prepared are you right now for such an event?
It is recommended, depending on your household size and need, that you keep a 3-6 month emergency fund available in a checking or money market account, where you can get to it easily and quickly, preferably with debit card and check-writing capabilities. To determine the amount you’ll need to save, add up your necessary living expenses for one month and multiply it by three for a 3-month savings or six for a 6-month savings.
A savings like this, however, should not be used for that new sofa you’ve had your eye on, or the family vacation you’ve always wanted to take. Hopefully it will remain largely untouched, but should a need arise, before dipping into your hard-earned money, first ask yourself, “Is it unexpected? Is it necessary? Is it urgent?” If the answer is “yes” to one or more of these questions, most likely you’ll need to use your emergency funds. Make sure when you do use your savings you replenish it for the next financial event.
The most important thing a savings can do for you is give you peace of mind. Next time the car dies or the water heater breaks, all is well in your world because you will have the money to cover it. Once you have a savings in place, any excess money can be used to invest.
"Financial peace isn't the acquisition of stuff. It's learning to live on less than you make, so you can give money back and have money to invest. You can't win until you do this." - Dave Ramsey
Investing: Simply put, investing is having your money work for you. The hope in investing is to make intelligent decisions with your money that will lead to financial security.
How do you choose the right investments for you? Know your options and do your research. From employer-sponsored retirement plans and solo 401Ks, to IRA’s and savings bonds, the options are endless, but also overwhelming. We will explore some of these options in future posts.
For starters, know that unlike banks and credit unions, the value of stocks, bonds and other securities fluctuate with market conditions, which can build your savings at a much faster rate. It is important to know, however, that investing has an element of risk and there are no guarantees. This means if someone offers you high returns with “no risk”, you should be skeptical. The stock market will always fluctuate, but history has shown that they always recover.
"You get recessions, you have stock market declines. If you don't understand that's going to happen, then you're not ready, you won't do well in the markets." - Peter Lynch
Time is the most valuable asset in investing: the younger you start, the more time for the interest you earn to keep earning additional interest, something called “compound interest”. With compound interest, the interest for the first period is added to the total. The new will then calculate the interest for the second period and so on. This allows for faster earnings and ends up being rather exciting. It looks something like this.
The world of investing can be scary, but with proper research and keeping a cool head about you, your chances of long-term success are good. Be willing to take the risk, ride the waves of market change, and watch your money work for you.
Let Me Know: What sort of “financial event” have you experienced where you’ve had to rely on your savings?