Definition
Investment refers to the process where individuals or businesses allocate resources, typically in the forms of stocks, bonds, or property, with the expectation of generating an income or profit over time. Savings, on the other hand, relates to setting aside a portion of income for future use, generally deposited in low-risk, readily accessible vehicles like savings accounts or certificates of deposit. The key difference is that investments carry risk and have the potential for higher returns, while savings aim for preservation of initial capital with very minimal risk.
Key Takeaways
- Investments and savings are two different financial strategies. Saving involves putting aside a portion of your income for short-term goals or for emergencies. This money usually grows at a very slow pace given that it’s often kept in low-risk, low-return instruments like a savings account. On the other hand, investing is the practice of using your money to buy an asset in anticipation that it will generate a return or profit over time.
- Investing generally carries more risk than saving. This is because the value of the assets you purchase may fluctify, sometimes dramatically, which can increase the likelihood of losing money, especially in the short run. However, these risks often come with higher potential returns compared to savings, which can lead to significant wealth generation over the long term.
- The choice between saving and investing depends on your financial goals, risk tolerance, and time horizon. If you need to use the money in the short term or can’t tolerate too much risk, saving might be a better option. If your goal is growing your wealth over the long term and you can withstand some risk, investing could be a suitable strategy.
Importance
Investment and savings are two critical components of personal finance that are often misunderstood.
The importance of distinguishing between the two lies in understanding their role in managing and growing wealth over time.
Saving refers to the process of setting aside a portion of one’s income for future use or emergencies, typically in a safe and easily accessible account, often yielding minimal interest.
Investing, on the other hand, involves channeling money into various financial instruments like stocks, bonds, or real estate with the expectation of achieving a higher return over time, albeit with additional risk.
This stark difference in growth potential emphasizes why it’s important to balance saving for immediate or short-term needs and investing for long-term wealth generation.
Explanation
Investment and savings, both financial terms, play substantial roles in individual and corporate financial management, and they serve different but interrelated purposes. The primary purpose of savings is to preserve and accumulate wealth over time, acting as a safety net for unforeseen circumstances, future purchases, or retirement planning. Savings are typically kept in safe and liquid forms, such as depositing money in a bank savings account where the value will not fluctuate dramatically but will generate a modest amount of interest over time.
During periods of economic instability, this can provide peace of mind and a sense of financial security. On the other hand, investing involves putting money into assets such as stocks, bonds, or real estate with an expectation of generating returns or income over time. Through investment, money has the potential to grow more significantly compared to conventional savings, due to the concept of compound interest.
However, it carries higher risk and is subject to market fluctuation. The primary function of investment is to generate wealth over time, often as part of strategies to achieve long-term financial goals such as sustaining lifestyle in retirement, growth strategy of a business or funding for large purchases. As such, understanding your financial goals, risk tolerance, and time horizon become crucial in deciding how you allocate your money between saving and investing.
Examples of Investment vs Savings
Purchasing Stocks vs Savings Account: Let’s say a person has a substantial amount of cash. They have two primary options, including investing it into the stock market or putting it into a savings account. If they choose to purchase stocks, this is an investment, and they are taking a risk in hopes of generating returns. However, if they choose to put it into a savings account, they are opting for savings. In this instance, their money is protected and guaranteed a small return through interest.
Buying a Home vs Renting: A homeowner considers their house an investment because over time, the hope is that the worth of the home will increase and they can sell it for a profit. On the other hand, those who choose to rent may chose to save their money instead of investing in a property. They might put the money that could have been used for a down payment into a savings account or other non-risk solutions, assuming it will be a safer option that will provide them with financial security.
Retirement Accounts vs Emergency Fund: A retirement account like a 401(k) or an IRA is an investment vehicle. Individuals contribute a percentage of their salary into these accounts for long-term growth. On the other hand, an emergency fund is essentially a savings account for unexpected costs— it’s not meant to grow substantially, but to serve as a financial safety net. Thus, one sees potential growth (investment), while the other offers stability and security (savings).
FAQ: Investment vs Savings
What does it mean to save money?
Saving money means setting aside a portion of your income that is not spent and is typically placed into a safe, low-risk, low-return account such as a savings account at a bank.
What is an investment?
An investment involves allocating money with the expectation of receiving additional income or profit in the future. Unlike savings, investments carry a level of risk and are not always guaranteed.
What is the difference between savings and investment?
The key difference between savings and investment is their risk and return profile. Savings typically have a low level of risk but also a lower return. Investments on the other hand have the potential for a higher return but also carry a greater amount of risk.
Is investing better than saving?
It depends on your individual financial goals and willingness to take on risk. If you are saving for short term goals or you need your money to be easily accessible, savings could be a better option. However, if you are saving for long term goals and you are willing to take on more risk for a potentially higher return, investing could be a better option.
What are the advantages of saving money?
Saving money allows you to have funds readily available for emergencies or short term goals. They are usually held in risk-free or low-risk environments where the principal sum is safe.
What are the pros and cons of investing money?
Investing can provide higher returns than savings, especially over the long term, which can be beneficial for long-term financial goals. However, investments come with risks and there is always the possibility of losing the money you invest. It’s important to consider both the risks and potential return before making an investment.
Related Entrepreneurship Terms
- Return on Investment (ROI)
- Compound Interest
- Risk Tolerance
- Diversification
- Liquidity
Sources for More Information
- Investopedia: A well-renowned source for finance and investing terms and concepts.
- NerdWallet: Provides financial advice, tips, and explanations on a variety of finance-related topics including savings and investing.
- The Balance: Offers expert insights on managing money, understanding different investment vehicles, and recognizing the difference between saving and investing.
- Bloomberg: Known worldwide for business and market news, they also provide quality educational resources on personal finance concepts.
