If you've already taken care of your essential expenses, such as bills and debt payments, and are wondering if you should save or invest money that's left, consider these things.
Where you put your money matters: Saving and investing
Investing involves the same behavior as saving—putting away money gradually over time to achieve a financial goal. Investing is riskier than traditional saving because you have the potential to lose money. The risk is compensated with a higher potential for reward. There are benefits to both, it just depends on what you want to accomplish with your money and the time until you need to access your money.
For short-term goals
Savings accounts at banks offer flexibility and insurance from the Federal Deposit Insurance Corporation (FDIC). Some brokerage firms offer cash management accounts. The Fidelity® Cash Management Account auto-sweeps cash into program banks, which provide FDIC protection up to a limit. Money in these accounts is liquid, meaning you can access it when you want or need to. A traditional savings account and a cash management account can both be good places to put cash that you need ready access to for paying bills or emergencies.
For long-term goals
If you're invested in riskier assets, money in your account will fluctuate based on how the market moves. It could be an option for money you'll need for long-term goals since you have more time, meaning more time to see the power of compounding at work, and more time to recover any experienced losses. Investing can reward you with the potential for more return than a savings account, which is important for goals that require a larger dollar amount, like buying a house or getting married. Just be mindful that this higher potential for a bigger return is always matched with a higher risk of loss.
Give me an example
Let's say you want to buy a house several years in the future. A down payment is a considerable expense that requires diligent savings habits. One option is to use a savings account to accumulate money toward the down payment. Though your cash may be safer, your money's growth potential is smaller due to a smaller growth rate. If you decide to buy riskier assets in an investing account, you're hoping to recoup any losses over a longer time horizon in exchange for greater growth potential for your money.
Should I invest first or save?
It's a good idea to set aside an emergency fund with enough money to cover those unexpected but inevitable "oh no" money moments. Fidelity believes that people should save enough to cover 3–6 months of essential expenses, like rent, bills, and debt payments. In general, it's best to put emergency money into short-term investments, as opposed to an investment account. Emergencies are unpredictable, so an emergency fund should be stable and easily accessible.
I've got an emergency fund. Now what?
If you have a workplace savings plan through your job, you should consider maximizing your employer match. Let's say your employer matches 100% of what you contribute to your retirement, up to 3% of your income. Even if you only contribute 3%, you're effectively doubling that amount to 6%. You can think of it as your company helping you build up your retirement account balance.
I have all that covered. What's next?
If you've already addressed emergency fund savings and are maxing out your workplace retirement savings, an investment account can be a good way to pursue other long-term goals. You can try investing some of your extra cash even if you have only a small amount to start with. Investments can benefit from compound growth.
Compounding: Earnings being reinvested to earn more growth
The snowball effect of compounding can be quite powerful, because if you have gains on your initial principal, you may then start making gains on the gains, and so on. As an example, an initial principal of $100 with a 10% return per year would be worth $110 after the first year, $121 after the second year, $133.10 after the third year, $146.41 after the fourth year, and so on. This is, of course, a hypothetical situation and assumes a steady 10% return per year, which is solely hypothetical, for illustration purposes only.
The snowball effect of compounding makes early investing, particularly in a retirement account where taxes are deferred, that much more enticing. The earlier you start investing, the more potential you have for compounded returns. Of course, there can be setbacks along the way, but over time, consistent investing has paid off. Additionally, the more you contribute to your retirement plan, the better; try to contribute the maximum amount each year so your principal may generate the most return possible.
Some things to be aware of
Keep in mind that all investing carries risk, which is why your emergency savings should be kept separate from your investing account. You should only invest money that you won't need for immediate expenses like bills. That way it will have time to recover from market downturns.
Save, invest—or try both
Saving and investing are essential financial tools. Stashing money into an account—whether it's savings, investing, or both—can help you reach your goals and build the life you want.