One of the most important gifts you can give the children in your life is financial freedom.
By passing on enough accumulated wealth, you can empower children to get out there and chase their dreams without having to run and hide from huge debt and missed opportunities.
But if you want your loved ones to benefit from that financial freedom, you can’t rest on your laurels. You need to think hard about how you want to make your money grow.
And, generally speaking, that means choosing between saving and investing.
This guide explains the differences between saving and investing, the basics of saving, the basics of investing, and how to decide if it’s better for you to invest or save.
Saving vs Investing: What’s the Difference?
A lot of people toss around the words “savings” and “investment” like they mean the same thing. And while it’s true that both saving and investing are two of the most important foundations of financial literacy, they’re actually very different.
The biggest difference between investing and saving is risk.
Generally speaking, saving is when you place money into some sort of savings account. This could be a Certificate of Deposit (CD), a money market account, or another type of mainstream bank account.
In placing money into a savings account, you expose it to minimal risk. Your chances of losing money are incredibly low, because the money you place into savings accounts generally won’t go anywhere, and will likely be insured up to a certain amount.
Meanwhile, investment is when you purchase ownership of an asset with the goal of generating income or an appreciation of that investment. This would then enable you to increase the overall value of your finances.
When you invest by purchasing something like shares in a company, you’re opening yourself up to a higher level of risk.
That’s because an asset like stock shares can fluctuate in value — and could end up becoming worth less than the amount of money you paid for them in the first place.
That equates to a loss.
But with those higher risk levels comes a higher chance for long-term gains. Just as the assets you’ve invested in can drop in value, they can also increase in value.
You generally won’t have the potential to make as much money on a savings account.
Likewise, investment and saving are going to accumulate different amounts of compound interest.
Saving money is great for those with a low risk appetite — but it also has little capacity to generate gains. There are some savings accounts that you get from banks (like Certificates of Deposit) that do offer customers (slightly) higher interest rates than ordinary savings accounts. This means the bank will essentially pay you interest as a reward for keeping your cash in savings.
Yet if you want to make your money work harder and generate higher returns, you’re going to want to consider investing rather than saving.
At the end of the day, saving tends to be a short-term financial strategy. Investment is all about the long term.
But if you really want to cover all your bases and start building a financial future for the people you love, you should be doing both.
By saving, you’ll be able to build up a “rainy day” fund so that you’ve always got liquid cash savings in case of emergency. By investing elsewhere, you can work to grow your money over time.
The Basics and Benefits of Saving
OK, so we’ve already covered in general what saving is, so let’s zoom in and explore how saving actually works.
At its core, saving is just the act of putting money away for a future purpose. When you save money, you’re going to want it to stay liquid in case you need access to it quickly (or immediately).
By “liquid,” we just mean that your money is accessible if you need it.
If you were to invest money in an asset, but then needed that money back at short notice, it may be difficult to get the asset sold and recover your cash at the drop of a hat (and, if you did, you might incur fees or taxes associated with cashing out).
But if you put money into a savings account rather than invest it, liquidity isn’t going to be a problem. You can get the cash whenever you need it.
According to researchers at FINRA, 46% of Americans don’t have a rainy day fund — which means that if an expensive emergency pops up out of nowhere, almost half of the people you know are going to be unprepared.
Don’t let that be you.
Savers normally deposit their cash into a low-risk bank account, though some savings accounts offer higher interest rates that can help you to build your wealth slowly as you save.
By selecting a bank account with the highest possible annual percentage yield (APY), you’ll essentially be rewarded with interest payments by the bank in exchange for keeping your money there.
But it’s important to note that some high APY savings accounts do have minimum balance requirements and rules on withdrawals.
For example, if you try to take your money back out of a CD before it reaches its maturity date, you’ll likely have to pay a penalty fee and could lose some or all of the interest you’ve earned.
One of the major benefits of saving is that savings accounts tell you upfront the interest levels you’re going to earn on your bank balance.
Perhaps more importantly, your risk levels are going to be lower than when investing.
In the US, the contents of all bank accounts are guaranteed for a value of up to $250,000 by the Federal Deposit Insurance Corporation (FDIC). That means you likely won’t lose any money when you’re using a savings account, even if your bank goes under.
The only way savers ever really lose money is if they incur loads of maintenance fees or Regulation D violation fees.
For reference, Regulation D is a federal rule that places a limit on the type and the number of withdrawals or transfers you're allowed to make from savings accounts or money market accounts per month.
Finally, saving is a great way to put cash away without relying on advanced financial literacy skills. Saving is straightforward, and it’s a simple thing to do. There’s no upfront cost, and there’s no specialist knowledge that you need or learning curve you must overcome to do it.
All this being said, bear in mind that saving does have a couple of key disadvantages.
As previously stated, the returns are low.
You have the potential to earn a lot more money by investing in assets rather than simply saving cash (though there’s no guarantee you’ll earn more). Investment is all about potential, and the assets or funds you’re placing faith in aren’t always a sure thing.
Also, since the returns on your savings account are generally going to be lower, you’ll probably lose purchasing power over a long period.
That simply means currency inflation will eat away at your savings, because the interest your cash savings generates could be outstripped by the waning value of your savings.
The Basics and Benefits of Investing
While saving is all about placing your cash in a safe place, investment involves spreading your money across different areas by purchasing assets (creating a portfolio, essentially).
Some assets are tangible things you can see and hold — like a real estate property you’ve invested in. Others are slightly less tangible — like company stock shares, mutual fund shares, or an exchange-traded fund (ETF).
When you’re investing your money, it’s typically with the goal of growing that money over a longer period of time.
Investment is all about placing money into something that you’re expecting to increase in value over time. For example, you might purchase stock shares in a publicly-traded company under the assumption that those shares are going to increase in value over time.
Yet by purchasing those shares, you’re opening your money up to risk through market exposure. After all, the asset you’ve purchased might not actually increase in value. It could end up dropping — which means you could end up getting less money back than you put in at the start.
Translation: with investments, positive returns aren’t guaranteed.
If you’re keen to invest and the markets go your way, you stand to gain a lot more money over time than if you were to shove it all in a basic savings account.
But these things tend to take time. That’s why you should aim to invest for at least five or more years. The longer your investment horizon, the more time you’ll have to recover your money if the investment temporarily decreases in value.
There are a range of investment options you can pursue if you’d like to invest some of your money rather than simply save it.
A lot of investors will opt for assets they can purchase and hold, like stocks or bonds. Others benefit from a more managed approach by placing money into an investment vehicle like a custodial account designed to hold multiple assets (including shares and bonds).
At the end of the day, if you want to be prepared to support the children in your life with a genuine financial legacy that can give them the gift of future financial freedom, simply saving isn’t normally going to do it. You’ve got to make your money work harder and invest to grow a nice big nest egg.
Is it Better to Save or Invest?
The short answer is that it’s better to do both.
Saving is a short-term financial strategy, and investment is all about the long term. In a perfect world, you should both invest and save to make sure that all your bases are covered.
When you’re deciding whether you should invest or save, the best way to start is by figuring out how much disposable income you can actually afford to put away each month.
Once you’ve got a figure in mind, you’ll be able to start thinking about how you can divide it up so that you’ve got enough to cover all the different periods in your life and all the people you love.
You could consider setting up an emergency fund in the form of a basic savings account to make sure that you’ve always got short-term, liquid cash whenever you or the children you love need it.
Next, you should consider things that you may need money for in the next 5–10 years.
Depending on your needs, you may opt for a high-interest savings vehicle or a lower-risk investment fund. For example, EarlyBird offers five different investment portfolios. For this time frame, one of the more conservative options (with more bonds than stocks) may be ideal.
Finally, you’ve got to think about all the stuff you want to do a decade or more from now.
This could be all those big-ticket items like paying for a child’s college, a wedding, or retirement. For all of these long-term expenses, consider investing.
Why invest rather than save? Simply put, savings can erode over time. By taking on a degree of risk through investment, you’ll have the potential to bring in far higher returns over a long period of time.
An increasingly popular long-term investment vehicle is an UGMA custodial account — which, when it comes to saving vs investing, gives you the best of both worlds.
A custodial account is an investment vehicle that allows an adult to set up an investment account for a child. The adult then serves as the custodian and manages all of the assets in that account until the child reaches that “age of majority” in their state.
Once the child hits the age of majority, the custodianship ends, and the child gains access to all the assets in the account.
A major pro of the UGMA account is that the money earned is taxed by the IRS at the child’s lower rate rather than the adult’s rate, up to a certain amount. This can save families a lot of money.
But an UGMA also offers a bit of flexibility in terms of early withdrawals — as long as those withdrawals are made for the direct benefit of the child.
If you set up a custodial account through EarlyBird, you’re also going to benefit from access to a range of investment portfolios designed to match your investment style and risk appetite.
EarlyBird is also unique in that it lets anyone — including friends, neighbors, or coworkers — contribute to a child’s financial future by investing in the account.
Remember: this is your loved ones’ futures we’re talking about, here. You shouldn’t leave anything to chance, and you can’t just sit around and hope something is going to happen. Think carefully, get professional advice if you’re unsure, and put your money to work.
When it comes to saving and investing, each one goes hand-in-hand with its own set of pros and cons.
But if you’re able to, you shouldn’t have to make a choice when it comes to saving vs investing. You should strive to do both.
Download the EarlyBird app now and start investing in the futures of the most important people in your life.