Saving and investing are very commonly seen as competing ideas. Many people feel that you can only do one or the other, with one involving hoarding money and the other involving risking money. The reality is that not only is there an overlap between the two, but both concepts are necessary for a healthy financial situation.
A healthy financial situation likely involves a mix of approximately 30% saving and 70% investing. However, this is only after saving up an emergency fund. Continue reading for more details on why this is the case.
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Definitions
Saving
Saving is pretty straightforward. Oxford Languages defines it as “keep and store up (something, especially money) for future use.” When it comes to our specific use in personal finance, we will define saving as simply holding onto money in a bank account, cash, or other uninvested, secure location.
This is the method of building wealth over time that your grandparents likely believed in the most.
Investing
Investing is defined as “expend money with the expectation of achieving a profit or material result by putting it into financial plans, shares, or property, or by using it to develop a commercial venture.” This is a much lengthier definition, but we can simplify it.
Think of investing as spending money expecting to receive more in return later. This makes sense when compared with the idea of the stock market.
To enter the stock market, an investor has to spend money in the form of buying shares. Then, to profit, the investor hopes to eventually sell the purchased shares for more than they paid.
Why Is It Necessary?
Saving
As you move through life, things will come up. These may be planned events such as buying a house, a big trip, a new car, or any other large purchase.
To be able to afford any of these, you need savings of some kind. It can be complicated and sometimes expensive to withdraw large amounts from investment accounts, making savings necessary.
These large purchases may also, sadly, be unplanned. Primarily, a surprise medical emergency can be far more expensive than it should be. Without savings, this can lead to debt and derail someone’s life. However, with savings, this can be a financial setback but nothing greater.
People who try to live without savings live one medical bill away from disaster. None of us are immune to random bad luck, so we shouldn’t live like we are.
Investing
Saving is fantastic for having money ready in case of an emergency. However, it doesn’t provide any real growth.
The traditional method of making money is strictly through job income. You must work for your money. However, investing offers an alternative to this—one where your money works for you.
In a job, the value you offer is your hard work, rewarding you with pay. This trade is based on you putting effort in to get anything out of it. On the other hand, investing creates value by simply using the money you already have.
See, people and companies need money to operate. The more money they have, the more they can produce and the more money they can make. Contributing funds to a given company or person provides value for them. This value is rewarded by returns, whether through growth or dividends.
In terms of the stock market, you are investing in companies whenever you buy shares of their stock. The higher a company’s share price, the more funds they have access to, usually in the form of loans. This allows them to produce more or produce more efficiently.
Investing is incredibly important because it is a secondary form of wealth-building on top of your job. Without it, you are missing out on potential wealth just by letting your money sit there.
To get started building wealth in the market the right way, follow this four-step checklist.
How Saving and Investing Work Together
Saving and investing don’t have to be mutually exclusive. In a few ways, they actually work together to build the best personal finances possible.
Risk Management
When it comes to investing, there is always risk involved. Even when investing in the safest fund on the stock market, risk is involved. Investments could drop significantly with little warning, and you must be prepared.
The best way to be prepared for a downturn like this is to have an emergency fund. An emergency fund is solely there to cover you in a sudden emergency where you need funds fast. Usually, this will involve sudden medical bills that can be thousands of dollars.
Emergency funds will usually be in a bank account or even cash. This keeps the funds secure, not vulnerable to volatility, and liquid. How liquid funds are is a description of how quickly they can be turned into funds able to be used to pay for things. A bank account or cash can nearly instantaneously be available for purchase.
Though the majority of your funds should be invested in some way, working for you, you need to have an emergency fund. Without one, you are inviting a disaster to occur where you get in more trouble because you have to sell investments and wait for funds to settle before they are available.
An emergency fund should be 3-6 months’ expenses minimum. This will be enough to cover an emergency as well as a gap in employment.
Only one or the other doesn’t provide the right balance of risk. Only having savings exposes you to too little risk and, therefore, growth. While only investing exposes you to too much risk and too little security.
To read more about emergency funds and how to best structure one, read this post.
Fund Large Investments
There are forms of investment other than the stock market. Though we speak primarily on the stock market at My Money Marathon, you can invest in just about anything. Any loan of funds to an individual or group with the promise of returns greater than your contributions is an investment.
The stock market is a flexible form of investing. You can invest any amount down to one dollar at any time you like and sell out at any time. Not every investment works this way.
The most common example is real estate. Most people who purchase a house do it with the goal of selling it for more than they paid. They are investing in the house with the hope of growth.
The difference is that real estate is far less flexible and requires far more funds upfront. This high upfront cost leads to you needing both savings and investments.
If you only have savings, you will need help to grow your wealth enough to afford the house in the first place. On the other hand, if you only invest, you can’t be sure what you can afford due to volatility, and you will have to plan farther in advance due to selling investments. Neither of these situations is optimal, with the best option being a mix.
A mix will provide growth and funds available to jump on opportunities as they arise. If you can save $20,000 on the house due to jumping on it more quickly than the next person, that is a no-brainer.
An infinite number of investments outside of real estate function the same way. Investing in yourself, your own business, a friend’s business, or any other growth opportunity requires a mix of growth and liquidity.
The Balance
There is no one answer for everyone. You can take on more risk if you already have a large amount of savings or low expenses. However, if you are working on building up savings or struggle to have any savings, you need to minimize risk.
For most people able to save some with average expenses, a balance of 30% saving and 70% investing is great. This provides substantial savings while exposing a large amount of funds to growth.
Again, this balance can be different for everyone. Work through the numbers for your situation to see if this balance works for you. Download the spreadsheet below to balance your expenses and read the accompanying post to work through this balance.
The Exception
To nearly every rule, there is an exception. This includes the rule of keeping a mix of savings and investing.
If you are quite risk-averse, want to grow your wealth, and want liquidity, a high-yield savings account is the way to go.
A high-yield savings account functions like a traditional bank account in terms of liquidity and lack of volatility. However, you earn a self-explanatory higher yield. Most accounts are as high as 3.5% or 4%. This return is 100% guaranteed, compared to returns in other investments, which are educated guesses that can fluctuate.
The only thing missing with a high-yield savings account is the high growth offered by investments such as the stock market and real estate. The best option is to mix high-yield savings with riskier investment accounts.
There are a few reputable high-yield savings accounts out there. The one recommended by My Money Marathon is SoFi which provides 4% returns with direct deposit. Sign up directly through my link to earn $25 when you sign up.
If you are interested in riskier investments, such as the stock market, sign up for Robinhood through my link to get $5-$200 of your choice of stock right when you sign up.
Closing Thoughts
Balancing your finances is tricky. Ultimately, the best balance is a mix instead of only saving or investing. They both have their advantages and disadvantages, and having both allows you to have the best of both worlds.
For more info on dividing up your income, check out my post on expense ratios. This post also has a downloadable spreadsheet to guide you through the process based on your situation.
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