You are putting money aside every month. Are you saving or investing? The difference may be subtle, but once you define whether you are saving or investing, you will be able to better choose where and how your money should be saved or invested.
Building Financial Security
Saving and investing are two separate but interrelated topics. You have to save some money to have the money to invest! That said, saving and investing are two factors towards building financial security.
The term saving can be given two possible meanings. Saving money or a savings plan involves taking a regular amount of money from your earnings and putting that money away for a future purpose. The money may be designated for a specific goal or it just may be for the reason to have more money set aside. If you do not already have a significant amount set aside for investment, a portion of your periodic savings money may go into your investments. This is savings as a verb or action.
Savings as a noun is money you have already accumulated and the money is in a financial product with safety and liquidity. If you put a $100 bill under your mattress every week, that pile of money is savings. It is safe and liquid -- you can easily get to the money of you need. Other types of savings vehicles will be discussed below.
Investments are financial products designed for the long-term growth of assets or wealth. The purpose of an investment is not to eventually spend the money on something, but rather use the accumulated investment money to earn more money and maybe you can live off those earnings.
Safe and Liquid
The money you have designated as savings may be designated for different purposes. Financial advisors highly recommend having three to six months worth of expenses set aside in a liquid account as an emergency fund. This would be considered savings. You also may be saving towards a specific goal, such as paying for a vacation, buying a new boat or a nice down payment on a new car. This money will also be in accounts classified as savings.
A financial product considered to be savings will be safe and liquid. Liquid means you can get at the money by making a withdrawal at the bank, using a debit card or writing a check. If you withdraw money there will be no penalties or chance of a loss. Common instruments used as savings are:
- Bank or Credit Union savings accounts. These are your basic savings accounts. You can make deposits or withdrawals at any time.
- Bank Money Market Account. The bank money market accounts were designed to compete with the money market mutual funds and pay a higher rate of interest. The number of transactions allowed in a money market account per month may be limited.
- Money market mutual fund. These are mutual funds which hold short-term liquid debt securities. The share value of a money market fund will stay at $1.00. Interest from the fund's portfolio will be paid as monthly dividends. Many money market funds offer check writing privileges.
Do note that in the current interest rate environment these financial accounts are paying almost no interest or maybe even zero interest. Accounts used for your savings will not be growing from interest earnings, only from the deposits from your personal savings program.
Long Term Growth
Investing covers a wide range of activities and financial products. Someone who already has accumulated a significant amount of money invests to keep his/her portfolio growing or to generate an income for other uses. Another person just starting an investment portfolio wants the value of the portfolio to grow from organic gains or earnings plus the "savings" he/she plans to add on a regular basis.
Here are some possible characteristics of different investment products:
- The possibility of capital growth. Capital growth is increasing share, unit or property value. For example, an investor buys shares of Apple in 2005 at $35 per share and now in 2011, those shares have grown 10 fold to over $350 each.
- An investment may pay a higher rate of interest than a safe savings account.
- An investment may include the risk of loss. Stocks, bonds and real estate can all go down in value as well as up.
- It may take some time to get money out of an investment either due to withdrawal penalties, the time it takes to sell the investment or you just do not want to sell when the investment is down in value.
Here are some of the more common choices for investing money:
The stock market: This avenue includes common stocks, growth stocks, high yield stocks, closed end funds, real estate investment trusts -- REITs -- and exchange traded funds -- ETFs.
Bonds: Bond securities include government, foreign, corporate and municipal bonds.
Mutual funds: Mutual funds are typically either stock funds or bond funds. Hybrid funds hold a balance of stocks and bonds.
- Investment real estate: Commercial buildings, rental homes or apartment buildings.
- Limited partnerships: These are broker sold units often involved in oil and gas exploration or production.
A final note on investing compared to trading. The financial news tends to be full of short-term results in the various markets. Traders attempt to profit from these short-term changes and trading tends to be more of a job or pastime. Investing involves selecting investment products for long term results, to build and investment portfolio and your overall net worth.