When it comes to financial advice, everyone has an opinion. Trying to decide what to do with your money can feel like hundreds of voices in your head giving contradictory demands.
“Buy a house”, “Save for retirement”, “Invest in a business” are all the common ideas of what to do with large sums of leftover income. But a lot of us don’t have large sums. We have what we don’t spend leftover at the end of the month. What do we do with that? Ultimately, the options often come down to two options: save or invest.
So, which one should you go for? Well, at the risk of sounding like another voice in your head, we’re going to break down the pros and cons of saving versus investing, and what you need to do to pursue either one, so that you can eventually make up your own mind.
Pros and cons of saving and investing
To put things basically, you can take a look at the pros and cons of saving and investing and perhaps even make your decision from there.
Investing has the advantage of being a long-term option, in that your money will have to take time to grow, allowing for compounding interest and means you’re less likely to use it up if you are saving for retirement, for example. However, it involves risk, and of course has the chance that your money might go down rather than up. Plus, investing might mean that you end up with a fine for trying to withdraw early.
On the other hand, savings are liquid money, which means you can access whenever you need to, which could be better or worse for you, depending on your financial goals and who you are as a person. And your savings are worth what they’re worth, without being subject to market volatility like investments would be. But the flip side of that is that you will miss out on market gains and gather no notable compound interest.
However, deciding between investing and saving isn’t as simple as flipping a coin and getting started. You have to be prepared for either of these options, which is why there is a common checklist to keep you and your existing finances safe while you play with your leftover money.
The first is a cash cushion, or savings that would cover you for three to six months if something were to fall through. You can find a breakdown of the different types of savings accounts here. If you don’t, you should start saving.
Are there any other short-term goals you need fast access to cash to cover, like vacation plans? That will take some savings then.
Do you think you’re likely to reach your retirement goals? Do you know what you’re doing when it comes to investment? Do you understand the risks and the fact that you might not be able to access your money until you’re over 59 without taxes or penalty fees? If you don’t see your current path playing out before your retirement and you think you know your stuff, you’re ready to invest.
As long as you are feeling comfortable with your current split between saving and investing every month, and you’re not falling short on either side, you’re ready to put your money where your mouth is.
Prioritizing your goals
There is no universal answer to whether you go for savings or investment. Even within savings there is the issue of short term versus long term savings. Do you want to save for travel or your cash cushion, or even retirement?
As a happy medium to hit all targets, you might want to ration out your extra income month to month. Say you have $500 left over every month, you can put $250 of it into investing for retirement, or half, $150 or roughly a third into your cash cushion, and $100 or 1/5 of it towards your travel goals. You can switch the ratio about to what is more important to you and adjust as you go.
How to save
There are a few different theories on what the best way is to save month to month. The popular vote at the moment is the 50/30/20 method, which is essentially what we were going for when describing rationing savings above. The theory was popularized by Senator Elizabeth Warren and says that your monthly income should be spent thusly: 50% on needs, like rent, utilities, food, and fuel, 30% on wants, like going out to eat, clothes, etc. and 20% on putting away for the future.
However, this is just an offshoot of the golden rule of saving: create a budget and stick to it. You already have the incentive in hand by creating and aiming for achievable goals. There are obviously a lot of life hacks to saving money, whether that’s with the aim of simply spending less or putting money away for another day, but they all come down to the core idea of being in the right mindset, which is made up of having goals and sticking to the plan. If you’re having trouble coming up with a budgeting plan, you can use the helpful calculator on the Investopedia website. There, you can break down exactly how much you are spending and where you are overspending in your budget.
Once you have a budgeting plan in place, you can decide where you can allocate your savings. Hopefully, with the help of this guide, you’ll be in a better position to split your money into short term and long term savings and investment options.