Saving vs. Investing: Key Differences, How To Choose

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Saving and investing are both important for building a sound financial foundation, but they’re not the same thing. It’s important to know the differences, and when it’s best to save vs. when it’s best to invest.

The biggest difference between saving and investing is the level of risk taken. Saving typically results in earning a lower return but with virtually no risk of losing your money. In contrast, investing offers the opportunity to earn a much higher return, but you take on the risk of loss.

Here are the key differences between investing and saving — and why you need both strategies to build long-term wealth.

Saving vs. investing: How they differ

While they share a few similarities, saving and investing are different in most respects. And that starts with the type of assets used for each.

When you think of saving, think of bank products such as savings accounts, money markets and certificates of deposit (CDs). And when you think of investing, think of stocks, ETFs, bonds and mutual funds.

The table below summarizes some of the key differences between saving and investing:

How are saving and investing similar?

Saving and investing have many different features, but they do share one common goal: they’re both strategies that help you accumulate money. Plus, both use specialized accounts with a financial institution.

• For savers, that means opening an account at a bank or credit union.
• For investors, that means opening an account with an independent broker, though now many banks have a brokerage arm, too. Popular online investment brokers include Charles Schwab and Fidelity.

Investors should have sufficient funds in a bank account to cover emergency expenses and other unexpected costs before they tie up a large chunk of change in long-term investments. You should only invest money that you can set aside for a while, such as five years or more.

The pros and cons of saving

Setting aside money in a savings account or similar comes with these benefits:

• Savings accounts tell you upfront how much interest you’ll earn on your balance.
• The Federal Deposit Insurance Corporation guarantees bank accounts up to $250,000 per depositor, per FDIC-insured bank, per ownership category. So, while the returns may be lower, you’re not going to lose any money when using a savings account if you stay within FDIC limits.
• Bank products are generally very liquid, meaning you can get your money as soon as you need it, though you may incur a penalty if you want to access a CD before its maturity date.
• There are minimal fees. Maintenance fees or Regulation D violation fees (when more than six transactions are made out of a savings account in a month) are the only way a savings account at an FDIC-insured bank can lose value.
• Saving is generally straightforward and easy to do. There usually isn’t any upfront cost or learning curve.

Despite its perks, saving does have some drawbacks, including:

• Returns are low, meaning you could earn more by investing (but there’s no guarantee you will).
• Because returns are low, you may lose purchasing power over time, as inflation eats away at your money.

The pros and cons of investing

Here are just a few of the benefits of investing your cash:

• Investing in stocks (or stock mutual funds or ETFs) can have much higher returns than savings accounts and CDs. For example, over time, the Standard & Poor’s 500 stock index (S&P 500), has returned about 10% annually, though the return can fluctuate greatly in any given year.
• Investing products are generally very liquid. Stocks, bonds and ETFs can easily be converted into cash on almost any weekday.
• If you own a broadly diversified collection of stocks, then you’re likely to easily beat inflation over long periods of time and increase your purchasing power. Currently, the target inflation rate that the Federal Reserve uses is 2%, but it’s been higher — at times much higher — over the past three years. If your return is below the inflation rate, you’re losing purchasing power over time.

While there’s the potential for higher returns, investing has a few drawbacks, including:

• Returns are not guaranteed, and there’s a good chance you will lose money at least in the short term as the value of your assets fluctuates.
• Depending on when you sell and the health of the overall economy, you may not get back what you initially invested.
• You’ll want to let your money stay in an investment account for at least five years, so that you can hopefully ride out any short-term downdrafts. In general, you’ll want to hold your investments as long as possible — and that means not accessing them.
• Because investing can be complex, you’ll probably need to do some research before you start. But once you get going, you’ll realize investing is doable.
• Fees can be higher in brokerage accounts, but many brokers offer free trades these days.

Which is better — saving or investing?

Neither saving nor investing is better in all circumstances — the right choice depends on your current financial position.

When to save money

• If you’ll need the money in the next few years, a high-yield savings account or money-market fund will likely be best for you.
• If you haven’t built up an emergency fund yet, you’ll want to do that before you dive into investing. Most experts suggest having three to six months worth of expenses (or more) set aside in an emergency fund.
• If you’re carrying high-interest debt such as a credit card balance, it’s best to work toward paying it down before investing.

When to invest money

• If you don’t need the money for at least five years or longer and you’re comfortable taking some risk, investing the funds will likely yield higher returns than saving.
• If you’re eligible for an employer match in your retirement account, such as a 401(k), contributing enough money to ensure you receive the match is key because the match is like free money.

If you have built up your emergency fund and don’t carry any high-interest debt, investing your extra money can help you grow your wealth over time. Investing is crucial if you’re going to achieve long-term goals like retirement.

Here are some real-world examples of when saving is better:

• If you’re paying your child’s college tuition in a few months, that should be in savings — a savings account, money market account or a CD that will mature before the money is needed.
• Same goes for an emergency fund, which should never be invested but rather kept in savings, so it’s there for you in the event of an illness, job loss or unexpected expense.

And when is investing better?

• Investing is better for longer-term money — money you are trying to grow more aggressively. Depending on your risk tolerance, investing in the stock market through exchange-traded funds or mutual funds may be an option.
• When you are able to keep your money in investments longer, you give yourself more time to ride out the inevitable ups and downs of the financial markets. So, investing is an excellent choice when you have a long time horizon (ideally many years) and won’t need to access the money anytime soon.

— Bankrate’s Rachel Christian contributed to an update of this story.