By Alix Logan
Saving and investing are both critical components of personal finance but they play very different roles in building wealth. In an ideal world, you want to get the most value for your money with the least amount of risk. So, when should you stay safe and save and when should you take more of a risk and invest?
Here I will be outlining some general rules or thoughts to consider when choosing between saving money or rather investing money. Unfortunately, this is not a black and white topic and there is a large grey area where you will need to consider your own circ*mstances. Let’s talk about it!
Generally, a savings account is where you should be keeping money you’ll need to spend in the next few years in order to meet your short term goals. This could be things like saving for your annual vacation, property or personal taxes, car insurance (if paid annually), charitable giving and obviously your emergency fund.
Returns are guaranteed and a good high interest savings account will offer an annual interest rate of 2.0% or higher. The key here it to utilize a high interest savings account to not only keep up with inflation, but potentially slightly beat it each year. You should ensure your bank is protected by CDIC and this will ensure eligible deposits up to $250,000 per account are covered. So, even if the bank you decide to keep your money at somehow goes out of business, you can rest easy knowing that you won’t lose a cent.
Keeping a good chunk of money easily accessible in cash is really important and acts as a monetary safety net. If times get tough and you need some extra cash, you’ve got yourself covered and don’t need to resort to debt.
Saving money should come before investing in most circ*mstances. The first step in managing your personal finances is spending less than you earn. Once you can do this, you can really start to make your money work for you.
Once you choose to take the next step and invest your money, you are buying something that you believe will increase in value over time. That is the goal, at least. Investing should come into play for your long term goals. These goals might include things like a downpayment on a home or your future retirement.
Remember, if you are considering investing but may need the money within the next 3 years, you should probably be saving that money instead. Do your research. Anything can happen in the short term, as we have seen with the recent market crash due to the global pandemic. While the markets are starting to recover, it will take some time to fully bounce back.
Imagine if you needed to cash out the money you invested while the markets were at rock bottom only about a month ago. You would have had to sell your investments at a major loss. Balancing a healthy savings rate in addition to investing is how we can try to not let that hypothetical situation become a reality in the future.
While having a healthy amount in savings as a monetary cushion is important, investing is crucial to building wealth over the long run. And generally when investing in a diversified pool of stocks, bonds, ETFs, etc., the longer the time frame, the lower the risk of your investment. By this I mean that if you start investing consistently at 20 years old until you retire at 65 years old, you are almost guaranteed an exponential return because of the effect of compounding.
Again, if you have a diversified investment portfolio of stocks, bonds, ETFs, or index funds you can expect an average return of about 5-7% annually over time. This does not mean you should expect a 7% return consistently each year, this is the average you hope and pray for over time. One year you could get a 20% return while the next year you get a -5% return and so on. If we look at the S&P 500 index over a long period of time, the average return is about
7%, adjusted for inflation. This also further clarifies why a longer time frame reduces investment risk! Look at how the returns fluctuate in the short term.
So with all of that being said, it’s clear that investing is riskier than saving because returns are never truly guaranteed. There is no insurance to protect your money if your investments go down in value. If you choose to invest, make sure you are mentally prepared to not see, need or use the money for the next 3-5 years (or longer if there is a market downturn).
Saving money in a high interest savings account is the best and safest option for the short term but in order to build wealth for the future, investing is crucial.
According to Statistics Canada, the average net savings for all Canadian households in 2018 was $852. Only $852!
The top 20% of income households saved an average $41,393 while the bottom 20% spent an average $27,935 more than their income. This means in 2018, the bottom 20% of income households either went into debt or had to withdraw from previous savings. Diving deeper and looking at the income of visible minorities in Canada, it is clear that employment and income barriers exist. A report by the Conference Board of Canada shows that minority workers make less compared to every dollar earned by a white worker. The racial wealth gap creates yet another obstacle for minorities and makes saving and investing over time much more difficult.
With Canada being one of the most racially diverse countries in the world, tackling racial discrimination in the work place and continuing to find ways to reach racial pay equity is extremely important.
“Earn as much as you can, save as much as you can, invest as much as you can, give as much as you can.”
Related Articles
The Basics of Investing In Canada
When Is The Best Time To Start Investing?
What Is The Tax-Free Savings Account (TFSA)?
How I Use My High Interest Savings Account
Disclaimer: I am not a certified financial planner or investment advisor. The ideas posted on this website are my own opinions on how I manage my personal finances. The content is specifically for educational and informational purposes and is not considered professional financial advice. Everyone’s finances work differently and you will have to do your own due diligence before making any financial decisions.
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