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.