In many people’s minds, the terms “saving” and “investing” are almost interchangeable. But there are some big differences — and you need to recognize them as you work toward achieving your financial goals.
Saving for the short term
You’ll need to save money, as opposed to investing it, for two main objectives:
• Emergencies — You’ll want to have six months’ to a year’s worth of living expenses readily available for emergencies — a big car repair, a new appliance, an unexpected dental bill, etc. You may want to keep these funds in a money market account, which offers liquidity and a rate of return that’s typically higher than a normal “passbook” savings accounts.
• Major purchases within next few years — Do you plan on making a down payment on a first home or a vacation home within the next few years? Or are you thinking about taking a long (and expensive) trip during that time? If so, you’ll want to choose the right type of savings vehicle. You’ll want to be pretty confident that your principal can be preserved, given that you’ll need the money in a relatively short time. Consequently, you may want to look at certificates of deposit (CD) and other short-term holdings, such as investment-grade corporate bonds and U.S. Treasury securities.
Investing for the future
If you’re investing to achieve a long-term goal, such as college for your children or a comfortable retirement, most individuals literally cannot afford to “play it safe” as you did when you just wanted to sock away money for emergencies or for a near-term purchase. Now, your chief goal is growth — and you may need lots of it.
To get this growth potential, you should consider investing in stocks; over the long term, stocks have historically outperformed all other types of financial assets. Of course, when you invest in stocks, you will incur some risk, because stock prices constantly move up and down and past performance does not assure future results.
You can’t control the volatility of stocks but there are things you can do to cut your risk. Here are a few suggestions:
• Put time on your side — The longer you invest, the greater your chances of overcoming short-term price drops and getting the type of growth you need to meet your goals.
• Diversify — If you own only stocks, you’ll probably be taking on too much risk. That’s why you’ll need to diversify your portfolio by purchasing bonds, Treasury securities and other investments. How you choose to allocate your investment dollars will depend on your individual risk tolerance, your specific goals and your time horizon.
• Look for quality — Generally speaking, you can get the greatest opportunities for growth from those stocks issued by fast-growing or “start-up” companies. And yet, these same stocks are often among the riskiest. Fortunately, you can still get strong long-term growth opportunities by investing in proven, high-quality companies with long track records of profits and earnings. These stocks are not risk-free, either, but over time they should prove considerably less “dicey” than their less-established peers.
Save first, then invest
Obviously, it’s important for you to both save and invest — and in that order. If you fail to build up your savings, you’ll end up raiding your investments to cover emergencies and purchases. So, save diligently and invest wisely. That’s a formula for success.