People want to build a financial foundation as they plan for their future by saving and investing. Therefore, most financial advisers recommend using both instruments for future financial planning. However, there is a difference between these because of their differing levels of risk. Savings typically have lower returns but no risk levels, whereas investing provides better returns but a higher risk of losses.
We look at their differences to determine why investing isn’t for everyone.
Different Ways to Accumulate Money
Whatever your strategy for accumulating money for your future, it needs to accommodate the levels of risk you are willing to take. Saving and investing are ways to help you do this, but they have different features.
Savers have several options, including opening an account at a bank or credit union or contributing to retirement savings accounts like a 401(k) or a Roth retirement account.
On the other hand, investors need an account with a brokerage firm (some are online) or an independent broker.
The plan is to save and grow sufficient funds for future use, including a dream holiday, retirement, children’s tertiary education, etc.
Savers and investors must ensure they have sufficient funds in a bank account to cover any emergency needs since long-term savings accounts are not easy to access, and investment products need time to show a profit.
Savings have lower returns and virtually no risk when the money is in FDIC-insured accounts. Furthermore, there is no difficulty involved in maintaining them; they are not expensive and offer high liquidity unless placed in a certificate of deposit (CD) or money market account.
Then again, investing carries various risks to your capital because you rely on the performance of stocks, bond yields, mutual funds, and ETFs. Moreover, there is a longer time horizon before you start seeing returns but a higher potential for them.
However, these investments can drop, but over the long-term, they tend to offer better protection from inflation than savings. On the other hand, these investments require much research, hard work, and diversification to ensure you spread your risk. Additionally, you might need to take a loss if you sell these quickly to collect cash. You also pay fees for some transactions and gains tax.
Drawbacks of Investing
Saving remains safer than investing and is ideal for people who prefer to take minimal risks. However, it doesn’t provide as much protection from inflation, and wealth accumulation is slower than investing.
There are several advantages to investing, especially if you consider the returns seen on the Standard & Poor’s 500 (S&P 500) that stand at an average of 15% annually from 2009 onwards. These are higher than those of savings accounts with higher interest returns like CDs and money markets.
Furthermore, one can easily convert stocks, bonds, and EFTs to cash on most weekdays. Making money with investments requires a diversified portfolio and research to ensure your returns remain above the inflation rate.
The potential for higher returns doesn’t convince everyone that investing is for them. Here’s why:
As we have seen over the last few months, investment values fluctuate, meaning no returns guarantee exists. People often fear not getting back what they initially invested during a period when the economy’s health is compromised.
Although interest rates can also drop, they tend to remain steadier long-term. People with savings can now look forward to higher interest rates as the U.S. Central Bank tries to curb high inflation rates by increasing bank interest rates.
Investment accounts generally require at least five years to balance economic growth cycles and downturns before you should start accessing them. Not everyone has the patience or discipline to watch the stock market and predict its cycles or the performance of specific companies. In addition, commodities markets tend to be susceptible to political and natural disasters, creating volatility, and investors need to have a certain degree of flexibility.
Furthermore, investing is complex, meaning you will have to invest time and effort before gaining the skillset for making the right choices, or you will need to find an investment expert. Each brokerage charges different trading fees, but some online traders have free trades.
Therefore, despite the possibilities of higher rewards, investments have more risk when compared to the various forms of savings. In addition, investors pay tax on gains, making it preferable for some people to contribute toward their tax-free retirement savings first before even considering investing elsewhere. Another benefit of saving in a retirement account is that any withdrawals of contributions have no penalties. Finally, if you aren’t keen on investing, choose your savings plans carefully to keep abreast of inflation at all times.