Savings and Investing…. What’s the difference?. Saving vs. Investing.
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The big difference between savings and investments is time. Savings is usually money you set aside for short-term goals. One reason you might save money now is so you have some money to invest later. Money deposited into a savings account is usually very safe and probably earns a small amount of money. Another great thing about a savings account is you can get your money out of the account whenever you want.
When you invest, you set your money aside for future income, benefit or profit to meet long-term goals. When you invest your money, there is no guarantee that your money will grow or increase. The earnings or losses from investments are usually more than what you would make or lose in a savings account. Investors recognize that it usually takes a long time to earn the big bucks, so most of the time they are in it for the long haul.
Time value of money is the relationship between time, money, and rate of return (interest), and their effect on earnings growth. A dollar you receive in the future may be worth more or less than a dollar in your hand today. That dollar will be worth more if you invest it and it grows in value. For example, $1 today might increase in value to $1.15 in two years. That 15¢ is your earned interest, which is the payment you receive for allowing a financial institution or corporation to use your money.
When many people hear the word “investment” they think of the stock market and the risks that go with it. Investments in the stock market do have risks and you certainly can lose money on stocks. Or any other investment for that matter. But with higher risks comes the potential for higher returns and rewards on your investments.
The risk to return relationship is another key investment principle. The more risk you take with your money, the greater potential return you receive. However, the reverse is also true, less risk and possibly the less return on your money.
People have different ideas about how much risk they should take with their money. Some are conservative and want to keep it some place safe, like a savings account. Others are more aggressive and are willing to invest it some place that could be a little more challenging, like the stock market.
Regardless of your investment style, every wise investor knows that diversification is a critical element in any investment plan. If you pay attention you can make it extremely simple for yourself. Diversification is the reduction of investment risk by spreading your invested dollars among several different investments. It is simply spreading your money around among different choices. When you divide your money up among different types of savings and investments, you reduce the chance of letting any one individual investment bring you to financial ruin, or harm your own financial stability.
Owner or Lender? If you are a lender, you lend your money to a business or the government and receive interest. If you are an owner, you actually buy a piece of a business and hope the business goes up in value. Lenders typically take less risk than owners, so owners tend to get paid more – but there’s no guarantee.
Savings accounts Banks and credit unions can pay investors to loan their money to these financial institutions. These payments are called interests, which can be defined simply as borrowing money, since the government insures that it will be paid back with interest. The only down fall could be low interest rates, however you can usually take your money out at any time with out any restrictions.
The federal government generates revenue when it sells savings bonds. Savings bonds are low-denomination, nontransferable bonds issued by the government. These bonds are usually available in denominations ranging from $50 TO $10,000 and they are purchased at a discount from their redemption amount. For example, a new $50 savings bond may be obtained today for $25, but it could take up to 18 years before it could be redeemed for the full $50, depending on the interest rate. The government pays interest on these bonds, but it builds the interest into the redemption price rather than sending checks to millions of investors on a regular basis.
Not to be outdone by the government, banks and credit unions have their own versions of bonds, called certificates of deposit. In exchange for loaning them your money for a set period of time – such as 3 months, 6 months, 1 year, 2 years, etc. – banks and credit unions pay you interest. The longer the term, the higher the rate of interest paid on the CD. CDs usually pay a slightly higher rate of interest than savings bonds. But like those bonds, you will lose a few months of interest if you cash in your CD early. CDs are attractive to small investors because they cost as little as $100. Investors can also select the length of maturity, giving them an opportunity to tailor the expiration date to future expenditures such as college tuition, a vacation, or some other expense.
Many banks, credit unions and mutual fund companies offer money market accounts. These work like checking accounts and pay you a higher rate of interest than savings accounts. Unlike CDs and savings bonds, you can take your money out whenever you want and usually with no penalty. Some financial institutions may limit the number of checks you can write per month or may require a higher deposit into the account to open it.
Out of all the income investments, these bonds typically pay the highest interest rates. Government bonds tend to be safer than company bonds, so corporate bonds usually pay higher rates of interest. The time periods for these bonds can be 2 to 30 years. In general, the longer the time period, the higher the interest rate paid by the bond. A bond has three main components: the coupon, or the stated interest on the debt; the maturity, or the life of the bond; and the principal, the amount that will be repaid to the lender at maturity. The principal is usually assigned a dollar value called the par value of the bond. Suppose, for example, a corporation sells a 6 percent, 20-year, $1,000 par value bond that pays interest annually. The coupon payment to the holder would be $60 annually (.06 x $1,000). When the bond reaches maturity, the company would retire the debt paying the holder the par value of $1,000.
Stocks are investments that represent ownership in a company. When a company first issues stock, it does so to raise money for itself. The company then puts that money to work to produce its product or service. It might buy some new equipment, or it may hire some new employees. The investors who buy the stock actually own a part of the company.
The stock itself sells for a price. A stock buyer wants the price of the stock to increase over time. Eventually, the buyer will sell the stock. Ideally, the process goes from “buying low” to “selling high.” The difference between the purchase price and the selling price is the investor’s earnings, which are also called a capital gain.
Over long periods of time, such as 5 to 10 years or longer, stocks tend to generate higher rates of return than income investments. But because stocks can also lose value, they are considered to be riskier than income investments. On the plus side, growth investments like stocks have historically earned rates of return that consistently exceed the rate of inflation.
When it comes to making investment decisions, investors always have a choice. They can do it on their own, or they can hire a professional to make their money management choices for them. Investors who want professional management turn to mutual funds.
A mutual fund pools money from several investors and uses the money to buy a particular type of investment, such as stocks. A fund manager, who is an investment expert, makes all of the buy and sell decisions for the investments in the fund. Because mutual funds own a variety of investments, investors enjoy the benefits of diversification. For these and other reasons, mutual funds can be a great choice for investing.
Mutual funds are created for several different purposes or objectives. Some are designed to produce income and invest in bonds, CDs, and other income-producing items. Some are designed for growth and invest in stocks or real estate. Mutual funds invest in almost any area of the business world. There are funds that invest in technology, in food and agriculture, in government bonds, in foreign countries and precious metals.