Saving money every month is an excellent first step towards greater financial stability, but the truth is that it’s only a first step. The next step, and the one that can result in huge monetary growth, is investing. Many people don’t know much about investing, especially if they didn’t learn about it from family growing up. Here’s what you need to know on how saving and investing differ, along with what makes investing so important.
What’s the Difference Between Saving and Investing?
Saving is simply the act of putting money away instead of spending it. The most common way to save money is through a bank account, although this isn’t the only option. If you put cash in a shoebox under your bed, you’re technically saving money, just not in a very secure way. Investing is spending your money in a way that you expect to pay off for you in the future. For example, if you loan someone $50 today with an agreement that they’ll pay you back with $60 in three months, you’d be making a basic investment. Or, if you buy one share of Apple for $175 on the stock market, you’d be investing with the hope that it will rise above $175 in value.
With saving, your money doesn’t grow. Technically, savings accounts pay a bit in interest, but the amount is so small that it’s inconsequential. With investing, your money can grow consistently, allowing you to increase the money you have without working. Saving doesn’t carry any risks, as long as you choose a safe place to save your money. Investing does, and the degree of risk typically increases with the potential reward. If you buy stable stocks of major corporations, your return will likely be under 10 percent annually, but it’s doubtful that you’ll lose money. If you buy shares in high-risk companies, there’s the potential for a huge return, but you’re also at a greater risk of losing your investment.
How Compound Interest Works
A key part of why investing, and doing so early, is such a smart decision is compound interest. When something earns compound interest, it means that interest is earned on the original amount (the principal) plus any interest that has already been earned. The other type of interest is simple interest, where interest is only ever earned on the principal. Let’s say that you deposit $1,000 each into two accounts, both earning an astounding 10-percent interest annually. One earns compound interest, and the other earns simple interest. After the first year, both accounts would have $1,100. But in year two, the account earning compound interest would have $1,210, while the account earning simple interest would have $1,200. In year three, the difference would be $1,331 to $1,300.
This difference may seem negligible, but over a period of decades, it’s massive. And that’s the benefit of investing your money into low-risk accounts that earn at least a steady 4 to 8-percent annual return. What you earn will compound over and over, and by the time you’re ready to retire, you’ll have much more than when you started.
Investments Needn’t Be Assets
When people think of investing, their minds usually go to the stock market or real estate investing. They think of putting their money in assets that will grow in value. This isn’t the only way that you can invest, though. It’s important to recognize that any spending you do to make yourself more money in the future can be considered an investment. Education is one of the best examples here. If you spend $35,000 getting your Bachelor’s Degree, that $35,000 is gone. You’re not putting it into an asset, which means it’s not what one would consider a traditional investment. However, it’s still an investment, only in this case you’re investing in yourself.
To confirm this, all you need to do is look at a comparison of lifetime income for people with Bachelor’s Degrees compared to people who stopped after getting their high school diplomas. The exact difference depends on more than just education (ethnicity, gender and location all play a role, as well), but it’s always at least several hundred thousand dollars, and often close to $1 million. When you look at it like that, a $35,000 investment in your education doesn’t seem so bad. You can also invest in relationships. And no, this doesn’t mean buying yourself a spouse. It means spending your money in ways that facilitates building valuable connections. For example, spending $500 to attend a business conference could be a worthwhile investment if you meet someone there who offers you a job or helps you grow your business.
The Wealthy Invest While the Rest Save
Now that you know the difference in investing and saving, along with how many types of investing there are, it’s time to look at the difference between how the wealthy use their money compared to everyone else. Wealthy people are always looking for ways that they can grow their money without increasing their workload. They put money into assets that they believe will grow, or they use it in a way that could boost their earning potential. They don’t just stash their money away and let it sit in a savings account earning .2-percent interest per year.
Most people fall into the category of savers and spenders. They may save money, but they don’t do anything with it. Often, they’re only saving up for something big that they want to buy, such as a new car or a vacation. Everyone saves or spends to a different degree, with some putting away a reasonable amount per month and others spending far too much. Either way, the result is that they’re being inefficient with their money. You may have noticed that in the descriptions above, we used the term “wealthy” instead of “rich.” Those two terms aren’t interchangeable. Being wealthy means that you know how to grow your money. Being rich only means that you have money. Someone could win the lottery and become rich, but it doesn’t mean they’ll start investing. They’re more likely to continue using money like almost everyone else does and eventually blow through their winnings.
If you want a brighter financial future, then investing is the best choice you can make for yourself. Select some low-risk investment opportunities, and you’ll have your money working for you.