This is a question that I have been getting a lot lately. More and more people are concerned about storing away for the future since COVID-19 has ravaged the global economy. And rightfully so. We should always prepare for our financial future because we simply don’t know what tomorrow holds.
As such, saving and investing are both important pieces of the puzzle. Both are critical tools for building wealth and for securing one’s financial future. This is why I always advise my clients to do both whenever possible. This is because saving and investing are both important and one only outweighs the other in regards to purpose.
What this means is that your decision to save or invest your money should be determined by your overall goal. There are definitely times when it is better to save than to invest and vise versa. But, this is ultimately determined by your individual financial situation. Let’s take a look at a few situations in which one option may prove better over the other.
In general, I recommend saving at least 3-6 months worth of emergency funds before you start investing. Emergency funds are the equivalent of all your essential living expenses. However, I recommend adding enough to cover non-essentials as well.
For example, if your living expenses typically add up to $3,000 per month then you should aim to save at least $9,000 in your emergency fund account. This is the minimum that you should store up – the more the better. Effectively you should strive to accumulate at least 6 months worth of living expenses in your emergency fund.
Emergency funds should be stored in a savings account because they are more liquid. This means you can easily access your funds in an urgent situation. Thus, you don’t have to depend on an upmarket to sell stock shares.
There are many options for storing money in savings accounts. Common savings options include regular savings, high yield savings, or money market accounts. I always recommend accounts with the best interest rates to my clients. This way your funds are earning money when they are dormant. They are also easily accessible to you when you need them.
If you are planning to make a major purchase, timing is very important in determining whether to save or invest. If you have less than a year to purchase the item, it may be better to save or purchase a certificate of deposit (CD). These are very low risk, highly liquid options.
Conversely, if you have more time such as three to five years, investing may be a wise choice. You can invest the funds for the purchase in a mixture of low and high-risk funds. This way you can get the best return on your investment. You can easily and quickly compound your money and still have the financial resources necessary for your purchase.
Financial Independence and Retirement
If your goal is to achieve financial independence or plan for retirement, a mixture of saving and investing is usually better. If you have more than 10 years before you reach your goals, aggressive investing is usually more effective. The more time you have to reach either goal, the more opportunity you have to make your money work for you on a larger, more rapid scale.
On the other hand, if you are closer to your financial independence or retirement goals you should definitely go a bit slower. You need to ensure that you will have the financial resources available to you once you leave the workforce.
In general, I recommend that individuals who are planning for financial independence or retirement to trade lower-risk options. Additionally, they should save a greater proportion of their money. The last thing you want to do is to lose your money right before it’s time for you to retire or resign. This will only prolong your time in the workforce and possibly lead to mental and/or physical health complications.