Understanding the Difference Between Saving and
Many individuals equate saving with investing. However,
these are separate, but equally important, financial tasks, according
to Pat Swanson, CFP® and families specialist with Iowa State
University (ISU) Extension’s Invest Wisely Project (www.extension.iastate.edu/investwisely).
Savings provide funds for emergencies and short-term goals. Safety
of these funds and ease of access are important considerations.
Generally savings yield a lower rate of return than investments. “You
may put your savings dollars into an interest-earning checking
account, savings account, money market account, or short-term
certificate of deposit (CD),” Swanson says.
On the other hand, the focus of investing is increasing your
net worth and achieving long-term financial goals. Investing
offers the opportunity for a greater return. Along with
this comes the trade-off of risk and the potential loss of principal.
In general, the higher the return, the greater the risk.
Most individuals achieve their long-term goals by investing – not
saving. Suppose you take $5,000 and put it in a savings
account earning on average a very safe 4 percent at the local
financial institution. In 20 years, the account will grow
to approximately $11,000. The funds are insured and the
interest rate is guaranteed.
An alternative is to invest the $5,000. “Since 1926,
the stocks of large companies have produced an average annual
return of more than 10 percent” Swanson says. At
10 percent, the $5,000 would grow to $33,600. However,
that return is not guaranteed.
Swanson cautions that investing in one company or even one
mutual fund involves significant risk. The funds aren’t
insured and over time the returns can fluctuate widely. Swanson
advises investors to have a long-range investment plan and stick
to it. “Investors must have some degree of tolerance
for risk, but by making wise investment decisions they can control
risk by selecting a portfolio of investments – diversifying.”
Keeping some funds in savings for emergencies is prudent planning,
but taking more risk to invest is required to obtain higher returns
and achieve long-term goals.
The ISU Extension Invest Wisely
Project provides a series of newspaper, radio, and web resources
for investors. It is funded by a grant from the Investor
Protection Trust (IPT). The IPT is a nonprofit organization
devoted to investor education. Since 1993 the IPT has
worked with the States to provide the independent, objective
investor education needed by all Americans to make informed
investment decisions. www.investorprotection.org.