Why is Investing More Powerful Than Saving? -Basic Finance Literacy

Does this question also come to your mind about why is investing more powerful than saving? Saving and investing are both important for having a strong financial base, but they are different.  Both can contribute to a brighter economic future, but knowing when to invest and save is important.  

The main difference between investing and saving is the amount of risk. Savings generally build low returns, and the risk is almost zero. However, investing carries a higher risk of losing money, even though it may build higher returns. 

These are the main differences between investing and saving and why both are needed for long-term wealth accumulation. 

What Do You Understand By Saving and Investment?

Saving: Generally, saving is the act of depositing money in a safe place that is easily accessible, such as a certificate of deposit (CD), money market account, or savings account. Preserving capital and guaranteeing liquidity are the main objectives of savings. Short-term purposes like setting up an emergency fund, buying a car, or traveling are common uses of savings. 

Investing: In contrast, investing involves purchasing assets using cash, with the expectation that their value will increase over time or generate income, such as stocks, bonds, mutual funds, real estate, or other investment vehicles. Long-term financial goals such as retirement, wealth creation, or paying college fees are often the focus of investing.

What Has the Highest Potential Return?

One of the most compelling reasons why investing is more powerful than saving is the potential for higher returns. Generally, savings accounts and other low-risk savings options offer nominal interest rates. 

Higher Potential Returns from Investing: Investing has the highest potential return compared to saving. Here is why: 

• Stock Market Investments: This investment has offered average annual returns of about 7% to 10%, which is higher than interest rates offered by savings accounts.

• Real Estate: This investment can also yield high returns through property appreciation and rental income. It provides substantial long-term gains.

• Bonds and Mutual Funds: While generally less volatile than stocks, bonds and mutual funds can offer higher returns than traditional savings accounts.

• Diversified Portfolios: Investors can optimize their returns. It can enhance the overall return potential of an investment portfolio.

Why Savings Have Lower Returns: Here are the reasons why savings have lower returns: 

1. Low Interest Rates: Generally, low interest rates are offered by certificates of deposit (CDs), money market accounts, and savings accounts. Since these rates are often lower than the inflation rate, savings may lose real value over time. 

1. Safety and Liquidity: Instead of big returns, savings products are built for safety and liquidity. They provide a haven to store cash for unexpected expenses or urgent situations, but their scope for growth is limited. 

How Powerful is Compound Growth in Saving and Investing?

One of the most powerful concepts in finance is compound growth, which refers to the process of earning returns on both the original investment and the accumulated returns from previous periods. It can accelerate the growth of invested capital.

Consider two people, Alice and Bob. Alice decides to deposit $5,000 annually in a savings account with a 1% interest rate. Bob decides to invest $5,000 annually in a diversified portfolio yielding a 7% average annual return. Let’s say they both start saving or investing at age 25 and do so until age 65.

1. Alice’s Savings: Her investments would grow to approximately $246,000 after 40 years.

1. Bob’s Investments: His investments would grow to approximately $1,068,000 after 40 years.

The power of compound growth is responsible for the notable discrepancy between the two results. Bob’s investments are sensitive to market fluctuations, but higher average returns make his portfolio grow much faster over time. On the other hand, we can say that investing is more powerful than saving.

What is the Best Way to Hedge Against Inflation? Saving or Investing

Inflation reduces the value of money over time. Let’s say you have saved some money. However, as inflation increases the cost of products and services, what you can buy with your savings reduces. 

Now, let’s say inflation is rising by 2% annually. If the interest rate on your account is barely 1%, your funds are not growing fast enough to keep up with inflation. Your real return is negative, especially -1%. It means that even though your bank account might show a higher number, the actual buying power of that money is less than before. 

Investing is more powerful than saving to fight against inflation. When you invest in things like stock, real estate, or other assets, there is a chance they will increase in value faster than inflation. But, investing comes with risks because the value of investments can go up and down. The potential for higher returns can protect your money from losing value over the long run.

In summary, if the interest rate you earn is less than the inflation rate, inflation reduces the value of your savings over time. Despite the risks involved, investing can provide high returns that will enable your money to grow and match or surpass inflation. 

Long-Term Wealth Accumulation

Investing is the best long-term financial growth strategy that shows investing is more powerful than saving.. Even people who start with a small amount of money can accumulate significant wealth through consistent investment management. This method, known as “dollar-cost averaging,” means you invest a set amount of money at regular intervals, no matter what the market is doing. This strategy helps you avoid bad decisions that can come from trying to guess the best times to buy or sell. You can reduce the impact of market ups and downs on your investments by sticking to this plan. 

• Real-Life Example: Check out the experiences of two famous investors, Peter Lynch and Warren Buffett.

1. Warren Buffett: One of the all-time best investors, Warren Buffett is also known as the “Oracle of Omaha.” He began investing at a young age and has amassed a fortune through a disciplined investment strategy focused on value investing. Buffett’s long-term approach and ability to identify undervalued companies have led to substantial wealth accumulation over decades. 

1. Peter Lynch: Peter managed the Fidelity Magellan Fund from 1977 to 1990 and achieved an average annual return of 29.2%. Lynch’s success was attributed to his thorough research. His abilities to identify growth stocks. His investment philosophy emphasized investing in what you know and understand. 

How Do You Balance Investing and Saving?

While investing offers the potential for higher returns, it is important to balance saving and investing based on financial goals and risk tolerance. Here are a few tips for achieving the right balance.

• Emergency Fund: Maintain a savings buffer to cover three to six months of living expenses in a liquid, low-risk account. It ensures that you have funds available for unexpected expenses or financial emergencies. 

• Short-Term Goals: You should prioritize saving in low-risk accounts to ensure the capital is preserved and available when needed for the next 1-5 years. 

• Long-Term Goals: The longer the time frame, the more you can benefit from the power of compound growth and the potential for higher returns. For long-term goals such as retirement or wealth accumulation allocate a portion of your funds to investments that align with your risk tolerance and time horizon. 

• Diversification: A mix of stocks, bonds, real estate, and other assets can provide a balance of risks and returns.

Read More: How Does Compounding Impact Investing?

Conclusion

Saving is important for immediate needs and financial stability, but investing has the highest long-term potential returns. The power of compound growth and expansion into other asset classes offers the potential for larger returns, making investing a more effective way to accumulate wealth. But, it is important to strike a balance between investing and saving. If you want to know why is investing more powerful than saving? This article is perfect to read. 

FAQs: Why is Investing More Powerful Than Saving?

How are saving and investing similar?

Saving and investing both involve setting aside money for future use. They aim to grow your financial resources and help achieve financial goals. Both require discipline and planning, though investing typically offers higher returns and involves more risk. 

Investing vs Saving, Which is Better?

Both investing and saving are important: saving provides security for short-term needs and emergencies, while investing offers potential for long-term growth. the best approach combines both, ensuring immediate financial stability and building wealth for the future.