Lesson How to set up financial goals

Saving vs. investing: Which is right for you?

The difference between saving and investing and how they can help you achieve your financial goals.

woman in front of a laptop

 

Have you ever confused saving with investing? This is an understandable mistake, as they are often used interchangeably in casual conversation. Both saving and investing involve setting aside money for the future, just in different ways. However, it’s important to understand the differences between the two to make informed financial decisions, set goals, and manage risk effectively.

What is saving?

Saving involves putting money aside in an account that earns basic interest to cover future expenses. Savings are commonly held in bank accounts where the funds are easily accessible for short-term needs. This can include vacations, renovations, a new laptop or phone, or any unplanned expenses, such as emergencies.

What is investing?

Investing involves buying assets such as stocks, bonds, mutual funds, real estate, or businesses in hopes of a return. Since investing offers the potential for long-term growth and compounding returns, it's often used for long-term goals such as retirement or a down payment for a home.

The differences between savings and investments

Both saving and investing play important roles in personal finance, and a holistic financial plan often incorporates both strategies. Here are the key differences between the two:

 

Objectives: Saving aims to provide a safety net for emergencies and to help set money aside for short-term goals. This strategy ensures that the principal amount remains preserved, without the risk of declining.

Investing allows your money to grow over time through compounding. This means that not only do you earn returns on your initial investment, but you also earn returns on the returns, creating a snowball effect. As your investment grows, the returns generated become more substantial, accelerating your progress toward your long-term financial goals.

Return Potential: While savings accounts provide a safe place for your money, they often yield lower interest rates. Savings accounts at financial institutions typically earn interest however, depending on the financial institution this may be lower or higher.  

If you deposit $1,000 into your savings account every month and it has an interest rate of 2.5%, compounded monthly, this means you’ll earn a total of $25 in interest after one year. *

Graphic illustrating compounding

*for illustrative purposes*

saving vs investing graphic

 

Compared to traditional savings accounts, investments have the potential to offer higher rates of return. Even though individual markets can have different and sometimes unpredictable performances each year, the S&P 500, a collection of 500 large companies in the United States, has historically grown by around 10.15% historically grown by around 10.15% each year .

If you buy individual stocks worth $1,000 in the S&P 500 and it grows by 10.15% in a year, your investment would be worth $1,115.50 at the end of the year.

However, remember that past performance doesn't guarantee future results, so be cautious and do your research when investing.

Time Horizon: Saving is designed for short-term needs, and funds are expected to be accessed within a relatively short time frame. Investing typically has a longer time horizon, often spanning years or decades, to benefit from the magic of compounding and potentially higher returns.

By starting early and consistently contributing to investing accounts, such as Tax-Free Savings Accounts (TFSAs) or Registered Retirement Savings Plans (RRSPs), you can take advantage of time and compounding to build a substantial nest egg for your goals. 

Accessibility: Savings are generally easily accessible and liquid, allowing for quick withdrawals when needed. Investments are typically less liquid, so it’s best to plan investment withdrawals ahead of time. 

Risk Profile: If you're anxious about investing, you're not alone. Saving is typically attractive for individuals with low risk tolerance because investing involves assuming higher risk, as investments can fluctuate in value, and there is a possibility of losing some or all of the invested capital. 

However, even with a low risk profile, there are still ways to invest. Through avenues like Questwealth Portfolios , you can be matched with an ETF portfolio that is managed for you and suits your risk profile and financial goals. 

Inflation Protection: While investing involves more risk, just saving money might not be enough to combat inflation, especially if the interest rates you earn on your savings are lower than the inflation rate. In this case, the value of your saved money may decrease over time.

Investing can provide a hedge against inflation by generating returns that outpace the inflation rate. 

Should I put money in savings or investments?

To set yourself up for a secure future, engaging in saving and investing is crucial.

The Financial Consumer Agency of Canada suggests you set aside three to six months of living expenses in savings before investing. If you don't have an emergency fund yet, prioritize saving and start investing what you can once you have a buffer in place. 

How much money you allocate to savings and investments depends on your income, age, risk tolerance, financial goals, and existing savings or investments. Understanding your financial position will help you make informed decisions about how much you can put in each. 

How much money you allocate to savings and investments depends on your income, age, risk tolerance, financial goals, and existing savings or investments. Understanding your financial position will help you make informed decisions about how much you can put in each. 

A final word

Remember that both saving and investing work in tandem to benefit you. As you allocate funds to savings accounts, such as a high-interest savings account, and investing accounts like the First Home Savings Account (FHSA), you take a proactive step toward building a stronger financial foundation and seeing your money grow over time. 

Ultimately, saving vs. investing is a personal decision for every Canadian that will depend on your unique individual circumstances and goals. However, no matter what your financial goals are, Questrade is here to help. 

Note: The information in this blog is for educational purposes only and should not be used or construed as financial or investment advice by any individual. Information obtained from third parties is believed to be reliable, but no representations or warranty, expressed or implied, is made by Questrade, Inc., its affiliates or any other person to its accuracy.

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