Saving and investing are both ways of setting money aside for the future. Both involve growing your money. And both should involve goals that make sense for your personal situation.
But there are a few key differences to keep in mind that can change whether you will meet your goals by saving or by investing.
Some accounts such as the Tax-Free Savings AccountTax-Free Savings Account A Tax-Free Savings Account (TFSA) is a registered savings account that provides tax benefits. In most cases, investment income, including capital gains and dividends, earned in a TFSA is not taxed, even when withdrawn. There are annual contribution limits but you can carry forward any unused contribution room from previous years.+ read full definition (TFSATFSA See Tax-Free Savings Account.+ read full definition), Registered Education Savings PlanRegistered Education Savings Plan A savings plan that helps you save for a child’s post-secondary education. The money that you save in the plan grows tax-free.+ read full definition (RESPRESP See Registered Education Savings Plan.+ read full definition), and Registered Disability Savings PlanRegistered Disability Savings Plan A savings plan that allows people with disabilities and their families to save for the future. Government grants add to your savings and your investments grow tax-free.+ read full definition (RDSPRDSP See Registered Disability Savings Plan.+ read full definition) can hold savings deposits and investments. Speak to your financial advisor about the strategy that’s right for you.
Saving helps you reach short-term goals
Saving involves putting aside some of your money to use in the future, often for a short-termTerm The period of time that a contract covers. Also, the period of time that an investment pays a set rate of interest.+ read full definition goal. It could be as modest as saving up for a new phone or concert tickets. Or it could be building an emergency fund to help you through an uncertain time in the future.
Usually, savings goals involve a specific amount of money that you know you need to save. For example, if you want to have an emergency fund worth three months of living expenses, you’ll be able to calculate that based on your current monthly spending.
You can set aside money for savings each month or each week, depending on your cash flowCash flow The sums of cash a business gets in and spends out during a set period of time.+ read full definition. Try to make it an automatic habit by setting up direct transfers from one bank accountAccount An agreement you make with a financial institution to handle your money. You can set up an account for depositing and withdrawing, earning interest, borrowing, investing, etc.+ read full definition to another.
Reasons to put aside savings:
- Meet your short-term goals
- Build an emergency fund
- Start a habit of putting money aside
Savings accounts keep your money accessible while it grows
Your savings should be kept somewhere you can access quickly when you need it, but still in a secure place. For example, a savings accountSavings account A bank account intended for depositing funds. Pays interest and lets you withdraw cash at any time.+ read full definition or a TFSA.
These accounts will also allow you to grow your money through compound interest. When you sign up for a savings account be sure to check the interest rates as well as the fees. Some savings accounts will yieldYield Your yearly return on an investment. It’s often stated as a percentage, such as 5%. With stocks, yield can be your yearly income from dividends. With bonds, it’s the interest you get.+ read full definition higher interest rates if you keep a higher balance.
The downside of savings accounts
Savings accounts tend to offer interest rates that are lower than the rate of inflationInflation A rise in the cost of goods and services over a set period of time. This means a dollar can buy fewer goods over time. In most cases, inflation is measured by the Consumer Price Index.+ read full definition. This means your money could have less purchasing power in the long run.
If you are paying off high interest debts such as credit cards, it may be better to pay these down first before focusing on large savings goals or investing. The interest accumulated on these debts will grow faster than the interest on your savings.
Investing has potential for higher returns but also more risks
Investing usually means buying assets or securities which hopefully, produces a return. In the long-term, investing typically provides higher returns than savings accounts.
Investments, like stocks and mutual funds, have historically provided returns higher than the rate of inflation over the long run. This makes investing ideal for long-term goals such as retirement, a home purchase or future incomeFuture income Money that a business or income trust expects to make in the future. This income is less sure than current cash flow. Also, a dollar may be worth less tomorrow than it is today. That’s why investors often discount the stated value of future income.+ read full definition. If you’ve already established a savings habit and are comfortable putting aside money for future goals, investing may be right for you.
The potential for higher returns means that investing can help you accumulate wealth faster. However, investing also involves more risk than saving. When you investInvest To use money for the purpose of making more money by making an investment. Often involves risk.+ read full definition, the value of your investments can fluctuate up and down, especially in the short-term. Its value can depend on many different factors, such as:
- the type of investmentInvestment An item of value you buy to get income or to grow in value.+ read full definition
- the performance of companies or a specific industry
- the economy as a whole
Generally, the higher the potential return of an investment, the higher the risk. There is no guarantee that you will receive a higher return by accepting more risk and you may lose some or all your money.
Knowing your risk tolerance level is important because there is no guarantee of a certain return.
Investing can involve more choices
There are many different ways to invest. Some investment accounts are designed for specific types of goals, such as a Registered Retirement Savings PlanRegistered Retirement Savings Plan A plan that lets you save for retirement while lowering your income taxes. You choose how you want to invest your savings. You don’t pay tax on any money in your account until you take it out.+ read full definition (RRSPRRSP See Registered Retirement Savings Plan.+ read full definition). You can also invest in different products outright, such as stocks, Exchange Traded Funds (ETFs), or mutual funds. Keeping a diverse portfolioPortfolio All the different investments that an individual or organization holds. May include stocks, bonds and mutual funds.+ read full definition is one way to manage risk.
Investing may be right for you if:
- You know your risk tolerance
- You are already in the habit of putting money aside
- You’ve paid off high interest debtDebt Money that you have borrowed. You must repay the loan, with interest, by a set date.+ read full definition
- You have long term goals to invest in
You may also like…
- 4 Reasons to keep saving even when inflation is high
- 8 universal truths about your money
- Opening an RESP when you’re not the child’s parent
- How RDSPs work
- Government grants and bonds for education savings
- Saving for long-term goals
- 10 mistakes first-time investors make
- Answers to investing questions you may be too embarrassed to ask
- Comparing short-term investments
- Preparing for financial emergencies