Normally after working for a year or two, you find yourself in the fortunate position of earning more than you spend. What to do with this extra money normally boils down to saving vs investing.
Contents: Saving money vs investing
- Saving vs investing meaning
- What’s the difference between saving and investing?
- Is investing better than saving?
- Should you save or invest?
- How much to keep in savings vs investments?
- Example budget of how much to save and invest
- When is the right time to invest?
Saving vs investing meaning
What is saving?
Saving is the process of putting money aside for future spending. The reason for saving is normally because you don’t have the amount of money you need to buy the thing you want or need now, so you need to ‘save’ some of your income on a regular basis until you have enough money. The most important thing about saving is to make sure you have the money when you need it. You can stuff cash under your mattress, or more commonly you would use a savings account at your bank to keep your money secure.
What is investing?
Investing also involves putting money aside for the future but the main difference is the purpose for doing so. The purpose of investing is to grow your savings at a faster rate than is available in a savings account to have more money in the future. The higher investment earnings are possible by taking higher risk with your money i.e. investments can do down in value as well as up. Investments can be done through a brokerage account or a multi asset investing platform like FlowBank.
What’s the difference between saving and investing?
The following table neatly explains the key differences between saving and investing. Your investing financial objectives, time horizon, need to access the money, risk level and profit potential are the swing factors for deciding whether you need to be saving or investing.
Source: Snider Advisors
Is investing better than saving?
Let’s go through the pros and cons of both saving and investing, as you might imagine there is no one ‘winner’ between saving versus investing, it depends entirely on your personal and financial circumstances.
Should you save or invest?
The general rule of thumb is to prioritise saving if you need funds in the near future and to prioritise investing when planning for your long term financial future.
Aside from your financial goals, there is also your own risk tolerance to think about. If you are somebody that would feels stressed to think your investments may have lost some money at some point in time, you might not have the stomach for investing. However, with enough understanding about the long-term expected returns in the stock market relative to the risk, most people that are worried about investing come around to the idea. Hiring a financial advisor is one way to overcome the fear of investing for the first time.
We can categorise financial goals by short, medium and long-term timeframe.
Short term goals like buy a car
For short term goals, you should take the least possible risk because you want to be sure you will have the money at a specific time, and the value of investments can go up and down in the short term. This investment account volatility generally means its better to put the money you need for the short term financial goal into a savings account or some other ‘liquid asset’ that holds its value.
[What is liquidity in finance? It is how easily you can convert an asset into cash]
Medium term goals like buy a house
For medium term goals, the priority also tends to be having the right amount of money available when you need it, as opposed to growing your money. However, since the timing of when you buy the house tends to be quite flexible, you can afford to take some more risk with low-risk investments. If the investments perform as you expect, you will have the money for the down-payment for the house quicker, if they do not, then you will likely not have to wait too much longer than if you had the funds in a saving account.
Long term goals like retire and/or gain financial freedom
History shows the investments offer a much greater return on your money than bank accounts with low interest rates. This has especially been the case since the 2008 financial crisis where central banks have kept interest rates historically low, close to zero percent. Over the long term, you can weather short-term fluctuations in your investment accounts in order to achieve the ultimately higher return from investing in stocks, bonds and commodities.
For most people, you will want to do a mixture of saving and investing. You will save for future purchases and invest to build your wealth.
There are no specific dollar amounts or percentages for how much to keep in a savings account versus an investing account. However, the 80/20 rule also known as the ‘Pareto Principle’ works for many people.
This works like the following
Budget: Spend 80% / Save 20%.
Once your income grows, you can save the amount and start to invest the remaining
Spare income: Save 80% / Invest 20%
Example budget of how much to save and invest
Let’s look at a very simple breakdown of a budget to include savings cash management and wealth goals.
Income: 5000 per month
Expenses: 3500 per month
Spare income: 1500 per month
Emergency fund: 5000
Total Savings: 1000
Financial Goals =
- Buy a new car = 10,000 CHF
- Deposit for a house = 30,000 CHF
- Be financially independent
The car in this example is the first priority, so all savings should be directed towards the car until he purchase is made. If the car is needed asap, then options include taking a car loan and then repaying the loan first. Once the car is bought, begin saving for house deposit and begin investing on 80/20 principle. Then use 80/20 again to pay off mortgage and invest. Then all extra income can be put towards investing with variosu investment types ranging from liquid to illiquid and low risk to high risk.
Financial Plan =
1st: Save 1500 per month saved until car purchased
2nd: Save 1200 per month towards deposit for house (20%) + Invest 300 per month towards financial independence until house is purchased.
Income rises to 6000 per month, expense rise to 4000 per month
3rd: Save 1600 per month to pay off mortgage + invest 400 per month
4th Invest 2000 per month
When is the right time to invest?
It’s good to start investing as early as possible to fully benefit from compound interest when you reinvest your investment returns. Read our blog on why start investing early for more information. But before you can start investing early, there are three steps
Step 1: Create an emergency fund for 1-3 months of income, then pay off debts
Step 2: Save some money in a regular savings account
Step 3: Note down financial goals
Step 4: Be prepared to commit to leaving the money alone for 2-5 years
Step 5: Get emotionally ready to ride the ups and downs of your investments
FlowBank offers a Swiss bank account with investing functionality, try the app by searching for 'FlowBank in the app store or try the desktop investing platform