I in a minute worked with a client who was 38 years old, single, and making $100,000 per year in income. She had $9,000 in her savings account and $112,000 in her [401(k)] retirement account, with a monthly contribution of 6% and a body match of 4%. She had recently paid off her student loan debt, which left her with an “additional” $800 at the end of each month.
She came to me with the anyway question many of my clients ask—should she save or invest her additional money? During our financial planning session to purloin her answer that question, we mapped out her financial goals and came up with the following:
Create a cash cushion of $15,000 in the next two years
- On the qui vive cash cushion = $9,000
Save an annual travel budget of $3,000 per year
- Current travel savings = $0
Save enough to go off at 65 with $60,000 per year until age 100
- Current retirement savings = $112,000
Key Takeaways
- What you need, when you stress it, and how much you can afford to contribute all factor into the decision of whether to invest or save.
- Usually, you would choose to seat your money for long-term financial goals like retirement because you have a longer time frame to take from stock market fluctuations.
- If the financial goal is short term, say five years or less, it’s usually smarter to woodland your money in a high-yield savings account.
Define Your Targets to Refine Your Approach
After we detracted out her financial goals, followed by the savings, investing, and interest required to meet them, we discovered the answer to her question. If she paucity to reach her goals, this is what she would need to save and invest every month:
- $250 per month toward her scratch cushion
- $250 per month toward her travel savings
- $525 per month in additional retirement savings, assuming:
- Annual average expansion rate pre-retirement = 8%
- Annual average growth rate post-retirement = 6%
- Inflation = 3%
- Amount of Social Security in today’s dollars bewitched at the full retirement age of 67 = $2,630
For this client, we approached the save versus invest question by reviewing what she had now and calculating what she could add in the prospective. What would meet her goals by her deadlines?
Prioritizing Goals
Because the total monthly dollar amount be short of to meet her financial goals was greater than the $800 per month she now had available, my client had a choice to make. Did she want to salvage her $800 for travel, pad out her cash cushion, or invest more toward her retirement now that she could see the required monthly investment to tourney each one?
This is why there’s no universal answer to the save versus invest question. What you need, when you call for it, and how much you can afford to contribute all factor into the equation. As a general guide, I advise my clients to examine a few key metrics to balm determine whether they should save or invest their money based on their specific circumstances.
Great term vs. Short term
Usually, you would choose to invest your money for long-term financial goals along the same lines as retirement because you have a longer time frame to recover from stock market fluctuations. But if the financial ambition is short term—say, five years or less, as it typically is for travel goals—it’s usually not a smart choice to invest your banknotes. In such cases, you’re generally better off parking it in a high-yield savings account because you wouldn’t have much all together to recover from a major downturn. Obviously, this is also based on your own unique risk tolerance and your whole financial health.
That’s why, for this client, I suggested she save a portion of her extra income for her short-term goals and a liquidate cushion while also still investing for her long-term retirement plan.
Pros and Cons of Investing and Saving
-
Initiating: The longer time horizon allows for compounding interest, growing your money.
-
Saving: Your money is fluent, so you can access it without penalty whenever needed.
-
Saving: You aren’t subject to market volatility.
-
Investing: Merchandises inherently involve risk, and investments may decline.
-
Investing: You may face a penalty for withdrawing the money too soon.
-
Saving: You’ll gal out on market gains and a potentially notable amount of compound interest.
I created a quick checklist to help others away this decision based on their own needs. Of course, it’s always best to work with your own qualified monetary planner, who can help you with your overall financial plan and make sure you are making the best decisions for yourself, but this is a horrendous start:
Save vs. Invest Checklist
- Do you have an adequate cash cushion that would cover three to six months of prearranged expenses? If not, then start saving.
- Do you have other short-term goals requiring quick access to cash (similarly to travel plans)? If so, start saving.
- Are you on track toward reaching your retirement goal by your desired age? If not, start spending.
- Do you understand the risks involved in investing this money for a long-term goal such as retirement? You may not be able to access it until age 59½ without cesses and a penalty, plus you’ll face volatility risk, etc. Are you comfortable waiting to access your money in order to take dominance of compounding? If so, you may want to start investing.
- Do you feel comfortable with your current split of saving and investing every month? Where does it know like you’re falling short?
Though this checklist won’t cover everything, it’s a great start toward envisioning the to be to come you want, plotting out how to get there, and preparing for what it will cost you. As always, it’s smart to work with your own fiscal advisor to review your current financial status, future financial goals, and the exact plan for reaching them.
Is It Wiser to Save Money or to Invest?
That really depends on your risk tolerance, financial requirements, and when you be in want of to access the money. Investing has the potential to generate much higher returns than savings accounts, but that sake comes with risk, especially over shorter time frames.
If you are saving up for a short-term goal and will sine qua non to withdraw the funds in the near future, you’re probably better off parking the money in a savings account. Conversely, if your objects are longer-term, you’ll generally find you can obtain more satisfactory results from investing.
Why Is Investing Money Riskier Than Nest egg Money?
Most bank and thrift savings accounts are insured up to $250,000 by the Federal Deposit Insurance Corporation (FDIC), intention if the institution holding the funds goes bust, you won’t be left empty handed. Investing doesn’t work this way. When you spend money, there is generally no insurance. You are essentially chasing a higher payout in exchange for the risk that you may not get everything break weighing down on.
Of course, not every investment is the same. Some offer higher potential returns and risk, while others are much bantam volatile, resulting in a lower chance of losing money and a lower potential payout. Generally, the higher the risk, the violent the potential reward.
How Much Should I Keep in Savings?
Opinions vary. Most experts recommend maintaining a moolah cushion of anything from three to six months of expenses to play it safe. Everything might be rosy today. In any event, there’s always a chance that you could at some point lose your job or get hit with a big unexpected bill.