Saving. Investing. It’s all the same, right?

Not necessarily.

When Vanguard clients come to me for financial advice, they often use the terms “saving” and “investing” interchangeably. Most of the time, they refer to longer-term goals—“I’m saving for my son’s college education,” for example, or “What’s the best way to invest in my IRA?”

But I’ve also seen clients treating “saving” and “investing” the same way; that is, they use the same approach or asset types to pursue a goal, whether short-term or long-term. For instance, one client who was still very much accumulating money for retirement asked me, “How much cash should I keep in my portfolio?” Another client told me he considered his stock funds his “emergency money.”

Saying “saving” when you really mean “investing” in a conversation with your financial planner isn’t going to impact reaching your financial goals. But acting like an investor when you should be acting like a saver, or vice versa, can have real potential to hurt your chances.

There IS a difference

Think of “saving” as putting money aside for a short-term goal, one that you’ll fund primarily with your own dollars. If you sock away money to purchase a home or replace your car, you have a saving objective. You’ll likely accumulate a small portion of the funds you’ll need from earnings, but the bulk of the money you’ll use will come out of your own pocket.

Conversely, “investing” is putting money aside for a long-term goal, one that will be funded a great with the year-in, year-out compounded returns of stocks and bonds. Amounts needed for retirement and possibly college are so large that likely the only way you can reach them is with the help of the investment markets.

Savings are “insurance,” not investment

Generally, you’ll spend savings within one to three years, so the risk you take with that money needs to be low. Money market funds, bank savings accounts, CDs— “cash” vehicles—are perfectly appropriate for savings, even in a low-interest-rate environment such as today’s. (See table below.)

Chuck Riley_Saving vs investing chart_2015

The reason? You don’t have time for returns to compound or, more important, to recover your money if an “investment” goes sour. Sure, whatever your savings earn will make little difference in reaching your goal. But losing 10%, 20%, or 50% of what you saved, by taking on the extra risk of stocks or longer-term bonds, could make a huge difference.Source: Vanguard, “Managing cash in a portfolio,” Kinniry and Hammer, October 2012.
Don’t lose sight of the importance of the last part of that statement: Low interest rates should not change where you put short-term savings.Source: Vanguard, “Managing cash in a portfolio,” Kinniry and Hammer, October 2012.

“Cash is not an investment,” I tell clients. “Cash is like a free insurance policy you own that ensures you’ll have the money you need to spend, when you need it.”

Invest with stocks and bonds, not cash

Since cash is not an investment, it really has no place in a long-term portfolio.

Holding cash in a retirement portfolio guarantees only one thing: low returns on that portion of your portfolio, which means less compounding and lower overall returns over the long run.

Investors who have been holding cash in money market funds the last few years, waiting for a stock market correction or a jump in interest rates, are still waiting (the last few weeks of stock and bond volatility notwithstanding). In the meantime, they missed out on 2013, one of the best years for stocks ever, and month after month of interest payments from bonds (which may have been low, but were still more than zero—the amount their money market funds have basically earned).

Cash savings have their purpose—for spending, and for the curveballs life can throw at us. Investments such as stocks and bonds are best suited for reaching those longer-term goals that most of us can’t reach by saving alone. Know the difference to give yourself the best chance of financial success.



Notes: An investment in a money market fund is not insured or guaranteed by the Federal Deposit Insurance Corporation or any other government agency. Although a money market fund seeks to preserve the value of your investment at $1 per share, it is possible to lose money by investing in such a fund.

All investing is subject to risk, including possible loss of principal.