Investing is the discipline of putting money aside with an expectation that it will earn a positive rate of return, and that over time those funds will grow in value. Investing is not the same as saving. But the terms are often used interchangeably. So, a discussion of the differences between saving and investing may provide a better understanding of just what investing means.
Time as a Component of Saving and Investing
Saving means something not used. Money saved is not spent. From a financial planning perspective, saving means deferring consumption. People put off spending money today so that they can have things in the future. Sometimes that future is right at hand. Other times it is many years away.
So, money reserved for imminent expenses might get exhausted quickly. Funds earmarked to finance long-term goals might be accumulated over several years.
Because various goals occur over time, money set aside to finance them might also consider time. Since funds aren’t required all at once, they don’t need to be available all at once. Savings and investment accounts may be tiered to match the timing of various goals.
The assets used in such accounts might also be similarly synchronized. Accounts intended to be accessed quickly might hold assets that reach their full potential promptly. Accounts meant to finance long-term goals might hold assets that develop over many years.
As such, time may be one of the variables that separates saving from investing.
Saving and Investment Risk
Another variable used to distinguish saving from investing is risk.[i] There are many saving and investing opportunities available to finance future consumption goals. Each comes with specific risks.
Some opportunities come with little risk of capital loss.[ii] Other opportunities pose a potentially higher risk of losing money. So, risk may also help define an opportunity as savings or investment.
The Expected Return of Savings and Investments
One of the primary differences between savings and investments is expected return.[iii] Expected return is what an asset might earn in the future. It describes the historical average return an asset class has generated over time. Some assets deliver high expected returns. Others are lower.
So, expected return is another factor that helps separate savings from investments.
Defining Savings and Investment
Clarifying the differences between savings and investment helps to specifically answer the question about what an investment is. Those differences are the time frame the asset might be owned, how risky it is, and what its expected return might be.
These unique characteristics might also be used to determine what asset class might be appropriate to finance a specific consumption goal. This is especially the case when one considers the timing and importance of the goal.
Near-term, high-priority goals might be financed with low risk assets. For example, those that are readily accessible (i.e., liquid), or have short-term maturities and have little risk of capital loss…even though they might offer a low expected return.
Goals expected to be attained in the long term might be financed with assets that offer higher expected returns and lower liquidity, even though they might put capital at risk.
So, savings might be defined as assets or accounts that are very short-term in nature, offer a high degree of predictability that capital deployed will be preserved, are very liquid, and that may offer a lower expected return than other opportunities.
Investing may mean owning assets or accounts that require a long holding period or limited short-term liquidity. Investing may come with a higher risk of loss than an asset used for savings. But investing may also provide higher expected rates of return than other opportunities.
In terms of one’s objectives, savings might be used for short-term, high-priority consumption goals. And long-term consumption goals might appropriately be financed with investments.
For help answering questions about various types of savings and investment vehicles, call us at (800) 235-8396.
[i] For purposes of this article, risk refers to the risk of a loss of capital invested. All saving and investing involves some type of risk, including the potential loss of capital. Investors should obtain relevant and specific professional advice before making any investment or other decision.
[ii] For example, the Federal Deposit Insurance Corporation (FDIC) offers limited protection against capital loss on some types of accounts held at some types of institutions. The FDIC does not insure any form of investment security.
[iii] Source: Consumer Financial Protection Bureau
