Whether to save or invest is a question many people have when starting out in their personal finance journeys. Saving is a priority for people without emergency funds or for people with short-term goals, like purchasing a home within the next year. But in many other scenarios, investing should be the priority. Clo Bare demystifies the best times to invest and the best times to save.
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Ahh, the age old question– should I save or should I invest? It’s something I get asked quite frequently and as much as I’d love to give a blanket answer for everyone– the real answer is: it depends.
The question of whether you should save or whether you should invest comes down to your financial priorities. There isn’t one blanket answer, but for certain financial priorities, one is better than the other.
In this post, I’ll cover a few different scenarios to help map out when you should save, and when you should invest. But first, let’s start with the pros and cons of saving and investing.
Disclaimer: I am not a CFP or CFA. This information is for educational and entertainment purposes only, and is not financial advice. For more information, check out my Terms & Conditions page.
Benefits and Drawbacks of Saving and Investing
Benefits of Saving Money vs Investing Money
There are so many benefits to simply saving more money.
1. Fast Access:
It’s great to have cash on hand for any expenses that might arise, and it’s also just great to be able to pay for things in cash when needed.
2. Almost No Risk:
Saving money also has almost zero risk– the money you put in won’t be lost or decrease (much) in value because most banks (certainly any bank I’d recommend) are FDIC insured.
FDIC aka the Federal Deposit Insurance Corporation insures that any deposit you put into an FDIC insured bank account is protected or insured.
That’s definitely peace of mind when you’re depending on that money being there for emergencies or a down payment on a home.
Learn how to save more money in “How to Save More and Retire a Millionaire at 50”
3. Simple AF
Another benefit of saving is that if you’re saving for a goal, you know exactly how much you need to save each day, week, month, etc and exactly how long it’ll take you to get to your savings goal.
For example, if you want to save $1 million in ten years, you know you have to save $100k each year or $8,333 a month in order to reach that goal. It’s pretty cut and dry.
Drawbacks of Saving Money versus Investing Money
Let’s be honest, there aren’t tons of drawbacks to saving money.
1. Inflation Makes Your Savings Worth Less Every Year
The only real drawback is that if you keep a large sum of money in savings instead of invested, your money will actually be worth less the longer it sits in a savings account.
Inflation can lower the value of money by upwards of 3% annually, so if you’re money is just sitting in cash or in a savings account– you’re losing about 3% annually.
2. Savings isn’t Making You More Money
The other downside of letting your money sit in savings is that it’s not making any money for you other than the low interest rates bank accounts usually offer– sometimes as low as 0.01%.
Even if the money is in a high-interest savings account, you’re still earning quite a bit less than what you’d earn in the stock market, over the long-term.
Benefits of Investing Money versus Saving Money
1. Your Money Makes You Money
Investing is a great way to grow wealth without lifting a finger.
The money and gains made through investing is what we call “passive investing” aka we didn’t have to do any work to make that money. The average return of the S&P 500, meaning the amount of money made on the investment, sits at about 10-11% annually.
This means you could make 10-11% off your investment annually, or 7-8% annually, when adjusted for inflation.
That may not sound like a lot, but if you invest $10k annually, your investments would increase to $153k in ten years despite only investing $100k of your own money. That’s a $53k bonus for doing nothing, and a 53% return on your initial investment. Not bad, eh?
2. You Can Reach Your Long-Term Goals Quicker
Because of these higher returns, if we have a money goal like saving $1 million, investing can make saving $1 million happen quicker than simply saving our money.
For example, if we invested $5k a month instead of saving $5k a month, we’d have $3.8 million saved in 20 years, assuming the stock market returns between 10-12% annually. In order to save $3.8 million dollars with just $5k a month, it would take us 63 years!
Drawbacks of Investing Versus Saving Money
1. Some Degree of Risk
The largest drawback of investing is that it does have some risks. An investment may go down in value as the market fluctuates– in fact at some point, it’s guaranteed an investment will go down in value to a certain extent.
2. Losing Value in the Short Term May Impact the Value of Your Investment
If you’re investing with a goal in mind, changes in the market may delay your ability to use the money for any kind of purchases.
For example, let’s say our goal is to have $100k saved for a home purchase so we invest $10k a month until our investments equal $100k.
Then, right as we’re getting ready to start looking at houses, the market dips, and we lose 30% of our investments, leaving us with $70k. Our only option then is either to put down less on the down payment, find a cheaper option, or wait until our investments reach $100k again.
When to Save and When to Invest
Now, like I said earlier, when to save and when to invest is a personal decision that will differ for each person. You may like having a larger nest egg than I do, and the next person may have a huge risk tolerance and is instead interested in investing all their money rather than saving.
To each their own, right?
There are, however, a few scenarios where saving or investing is generally more beneficial.
Saving vs Investing: When to Save
1. When You Don't have an Emergency Fund
I know, I know– we’ve heard this a million times before, but having an emergency fund is one of the most important financial tools to have in our money arsenal.
It prevents us from having to use credit cards and going into high-interest debt. Recovering from high-interest debt straight up sucks, and getting a fully-funded emergency fund can mean the difference between struggling for a few years or struggling for a few weeks or months.
If you’re not sure where to start, aim for saving $1k for emergencies, and then? Work your way towards 3 months of emergency expenses saved, and then, if you can, save up to six months.
For more on how to create an emergency fund, check out my post: “The Ultimate Guide to Emergency Funds”.
2. If You're Saving for a Down Payment on a House
If you’re saving for a home or rental property, you’ll want to have that cash available. In some markets, homes can be bought the same day they are listed, and having a down payment readily available for when you make an offer could make or break a deal.
The stock market can be volatile in the short term, so it’s important to not invest this money meant for a down payment. If you invested it, you risk losing your investment in the short term and delaying the purchase of a home or rental property.
3. Making a Big Purchase in the Next Few Years
Another reason to save is if there’s any other major purchase anticipated in the near future, for example like a car purchase planned a year from now.
Some experts even recommend having any major purchases within the next five years saved, instead of invested.
The reason for this is the same reason you’d want to have your down payment saved– in the short term the market can be volatile and you could lose up to 50% of your investment or more if the market goes down.
If planning five years in advance seems impossible, try to save for any foreseeable expenses, and take it from there.
Investing Versus Saving: When to Invest
1. You already have an Emergency Fund, and you Don’t Plan on Making any Large Purchases in the Near Future.
If you’ve already got an emergency fund of 3-6 months, and you aren’t planning on buying a house or a car or having a kid in the near future– focus on investing.
I like to think of investing as using the money I don’t need right now to make myself more money. If you aren’t planning on any big purchases in the near future, do you really need a big chunk of money sitting in your bank account? Probably not.
2. You've already Paid Off Your High-Interest Debt.
If you don’t have any high interest debt eating away at your income, then investing makes sense. If you do have high interest debt, talking about anything above 5%, then instead of investing, it makes more sense to get that paid off.
This is because you’ll lose more money by not paying down your high interest credit card debt than what you would make in the market.
For example, if your credit card is sitting at a 12% interest rate, and when your money is invested you only make about 7-8% interest, that means you’d be losing 3-4% (12%-7/8%) by not paying down the credit card debt first.
3. You have an Employer Match with your 401(k)
Now, EVEN IF you have high interest credit card debt and no emergency fund, you should ALWAYS get the employer match on your 401k.
That’s free money– basically part of your salary. Don’t leave it on the table, contribute up to the match, and invest the funds in your 401k.
4. You have Long-Term Money Goals (like Retirement, Work Optional Status or Early Retirement)
If you have long term goals for your money and are looking to build wealth over the years, investing is the way to go. Over the long term, investing provides greater returns, by far, than simply saving would.
Saving Versus Investing: You Can Also Do Both
Now, with the above guidelines, it’s important to note that you can do a little bit of both.
You can invest a bit, while also saving, especially if you have no high-interest debt.
Over the last several years, I’ve done both. I’ve paid off debt, invested in my 401(k) and saved for an emergency fund.
Whichever your biggest priority is, whether saving cash for college or paying down debt, this will inform where you dedicate the most resources.
In the past, paying down debt was my highest priority so I’d dedicated $2k a month to debt, $800 to my 401(k) and a couple hundred to my emergency fund. This allocation has changed as my priorities have changed.
Now, I’m focused on saving for a down payment on a rental property so I’m working on stacking cash in my high-interest savings account, while also maxing out my 401(k) and putting the minimum on my student loans each month.
Like I always say, personal finance is personal. Run some numbers to help inform your priorities, and save, invest, and pay down debt accordingly.
Saving Vs. Investing: What are you doing?
Tell me what your preference is and why down in the comments below!