It seems like every expert has a different opinion of whether you should save or invest your money, and how much you should have saved before you start investing. It’s an important question, but it isn’t that simple.
Should You Save or Invest
The problem with the expert’s advice is that it isn’t nuanced. They don’t know your individual situation or your personal goals. And the answers to most of the questions about saving vs investing are highly dependent upon those things.
Many online financial experts will tell you that you should start saving first – having an emergency fund should be your number one priority! And that’s great, it is a super important thing to save for. However, I’d argue that if you have access to a company sponsored retirement plan that matches your pay, you should invest in that before funding your emergency account. The most obvious reason is the free money. Most companies offer to match a percentage of your contributions, generally up to 5%. You are highly unlikely to find guaranteed returns of 5% anywhere else. So although saving for an emergency is extremely important and shouldn’t be put off, getting the match will give you the biggest bang for your buck.
Is Saving Better than Investing?
Saving is not better than investing, they are just different. Saving does have one glaring advantage, and that is that you won’t lose the money you’ve saved. Most banks are FDIC insured for $250,000. That means even if your bank goes under, your money is insured by the federal government and you won’t lose it. The peace of mind of putting money into savings over investing is unrivaled.
Another advantage to saving over investing is that you have quicker and easier access to your money. This is why it’s recommended that you have an emergency account in savings. In case of emergency, you can quickly access your money. If it were all tied up in investments, you’d have to sell and wait to collect the returns. Some investments have penalties for early withdrawals as well.
But the two advantages of saving don’t discount the giant advantage of investing, and that’s the opportunity for your money to grow. Savings accounts don’t pay dividends, and the interest they do pay is generally under 1%. You won’t even beat inflation if you keep all of your money in savings accounts!
That’s why it’s best to have a combination of both. You get some security in your savings account, and you get the growth of having investment accounts.
How Much Money Should I Save Before Investing?
I know you would prefer it if I gave you a straight answer, like you must save $1000 before you start investing. But that’s not realistic. The savings target is different for everyone, because everyone has different incomes, budgets, and goals. Some people have access to an employer sponsored account with a match and others do not. So, instead of telling you a number, let’s explore the different factors that come into play when you are deciding how much money you need to save before you start investing.
How Much Money Do You Need in your Emergency Fund?
Before you start investing all of your extra money, you should have a fully funded emergency account. But what that means is different for everyone. Most experts recommend having 3-6 months of salary saved, in case of the worst types of emergencies – job loss. This will give you a nice cushion so you won’t have to stress about finding another job immediately.
But do you have to have a fully funded emergency account before you start investing any money? I don’t think so. I don’t have a fully funded emergency account, so I budget some money each month to go towards that, and invest some into my Vanguard total market fund. This way, I’m building up my emergency account, but I’m not losing out on investment gains.
I like the balanced approach because six months of salary is a lot of money. It would take me forever to save that much, and I don’t want to miss out on years of investment gains while I’m trying to achieve my savings goal.
The point is, you don’t need to have a fully funded account before you start investing, but you should absolutely have something in your emergency account first. You never know when the car is going to break down, or your kid is going to get sick, or your dishwasher is going to decide to stop working. I think that $1000 we talked about above is a good solid number to have socked away in case of that type of emergency. Once you get there, you might be able to start investing – but an emergency fund isn’t the only consideration.
What Are Your Money Goals?
The next big question you need to answer before deciding whether to save or invest your money is what your money goals are. Why are you saving and investing? What’s the point? Now you may not have a point, you may just want to have money stockpiled so you can start building wealth. If that’s the case, you can start investing as soon as you get your 1K in your emergency fund!
Everyone has different money goals though. Maybe you are saving to buy a car or a house. Or maybe you are saving to pay for college or retirement. You may even be saving for a vacation, or for a combination of things! Your goals are personal and mean a lot to you, so whatever your reason for saving, it’s ok to acknowledge it and work towards it. But different goals will have different answers to whether you should save or invest your money. In general, the more money you need for the goal, the better it is to invest it. That’s why there are special investment vehicles for huge things like retirement and college. It’s difficult to save enough money for those things without getting those sweet investment gains.
What’s Your Time-frame?
The last big question, and one that goes hand in hand with the money goals question, is what is your time-frame. If your goal is to buy a house in the next year or so, then you should absolutely be saving your money. On the other hand, if your goal is to buy a house in five to ten years, you should be investing that house money.
This strategy generally works for any large savings goal. If you have a lot of time, it’s best to invest the money, because over the long haul, you will generally make money (but please be advised that any investment comes with risk – do your research before choosing an investment. If you are stuck, check out this beginner’s guide to investing). Markets fluctuate way too much in the short term for them to be a good vehicle to store money in that you will actually need soon. Day by day, stocks are up and stocks are down. It’s just the nature of the economy. But they do tend to trend upwards over time, so they are amazing for long term savings goals, such as retirement, college, and even houses if the purchase is going to be far in the future.
If you are saving for short term goals, such as a vacation, or a car, putting your money in the bank is the best option. This way, you can guarantee that the money will be there when you are ready to make your purchase.
Where is the Best Place to Invest Your Money?
There are tons of people who will tell you that they know the best investments for you, and many of them are trying to get a piece of your hard-earned cash. That’s why I think that the best investment options are the ones with the lowest fees. I have most of my money in a Vanguard ETF. The fees are low and it tracks the market so it’s instantly diversified. And no, I’m not affiliated with Vanguard in any way (other than having an account with them) so I won’t make a penny if you click on this link and set up your own account. I just really like their services.
There are other investment options if you aren’t interested in an ETF. You can build your own portfolio of stocks, invest in real estate (either through an REIT or by buying your own land and renting it), buy a mutual fund, or use Peer-to-Peer lending. All of these options have their own advantages and disadvantages, so do your research before making a commitment.
How to Save and Invest Money Wisely
Well, if people knew the real answer to this, everyone would be a stock market millionaire, wouldn’t they? But really, it’s not as complicated as it seems. All you have to do to save and invest wisely is be patient and diversify. I know that sucks, but it’s really the truth. Don’t try to time the market to score big gains and don’t act on hot tips from your sister’s cousin’s best friend. Buy quality products that have diversification built in (like Vanguard’s ETF) and hold on to them, even during downturns (especially during downturns!). Keep your emergency fund fully funded so that you won’t have to cash out of your investments during downturns. It’s really that simple.
So, Should You Save or Invest Your Money?
If you made it this far, you’ve realized that the answer greatly depends on you and your personal goals. Decide what those goals are, and start letting your money work for you!
Melanie launched Partners in Fire in 2017 to document her quest for financial independence with a mix of finance, fun, and solving the world’s problems. She’s self educated in personal finance and passionate about fighting systematic problems that prevent others from achieving their own financial goals. She also loves travel, anthropology, gaming and her cats.