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By Lois Sullivan
When you're setting financial goals and working to achieve them, you may wonder how saving and investing differ. While both play an important role in achieving financial security and success, each takes a different approach. Understanding when to use a savings versus an investment account can help you feel more prepared for your future and make smarter financial decisions.
A savings account is a deposit account offered through a financial institution. Most savings accounts offer a moderate interest rate, and the funds stored in a savings account are insured by the federal government up to $250,000 for security. Putting aside money in a savings account allows you to prepare for short-term needs, as the funds are accessible at any time. If you lose your job or experience a financial emergency, you can use the money you've saved for living expenses or to cover an unexpected cost.
Although savings accounts may have some limitations on how often you can withdraw funds, they're generally considered to be more liquid or accessible. This is one of the key ways in which savings and investment accounts differ, as the money in an investment account may not be available right away. A savings account is a flexible option you can use to build an emergency fund, save excess cash to get a higher interest rate, or even set aside money for a short-term goal like a vacation or new car.
One of the benefits of using a savings account is the security afforded by this type of financial account. You can move extra money into your savings account if you're tempted to spend what's accessible to you. For some people, the concept of "out of sight, out of mind" is successful when it comes to moving money out of a checking account, where it's even more accessible for spending.
The drawbacks of savings accounts are generally minimal. You may not earn as much interest as you would by keeping your money in a higher-risk account. Savings accounts may also have restrictions around minimum balances and withdrawal frequencies, but having a savings account is generally a good idea, especially if you have one in addition to other types of accounts that offer higher returns.
An investment account holds the investments that you sell and buy, as well as the cash used to fund them. This type of account allows the owner to make transactions with funds, bonds, stocks and exchange-traded funds (ETFs). People can choose from several different types of investment accounts.
The most common investment accounts are retirement accounts. Like the name implies, retirement accounts are used to set aside money for retirement. An individual retirement account (IRA) has a single owner, and that individual has access to various investments. Companies can offer 401(k) accounts to their employees, and many offer programs that match some or all of the funds that employees contribute to their accounts. Small business owners and self-employed people can also qualify for other types of retirement investment accounts, such as the solo 401(k), SIMPLE IRA or SEP IRA.
Investors can also open brokerage accounts, also known as non-retirement or taxable brokerage accounts. This account type provides access to various investment opportunities, including mutual funds, exchange-traded funds, bonds and stocks. If your investments earn interest, dividends or gains, you will report these amounts on your taxes as they become part of your taxable income. A brokerage account can be owned by an individual, known as an individual taxable brokerage account, or two or more people, known as a joint taxable brokerage account.
Another type of investment account available is an education account, also known as a 529 savings plan or account. You can start an investment account on behalf of your child and save money for their future education costs. Investors in nearly every state can open a 529 account to take advantage of the tax benefits, as qualified distributions or money spent on qualified education expenses are tax free.
Parents can also establish investment accounts for their children that aren't tied to educational requirements. The two main types of investment accounts for kids are covered under the Uniform Transfers to Minors Act (UTMA) and Uniform Gift to Minors Act (UGMA). The account types differ in the type of assets that each can hold. An account related to the UTMA can hold cash, mutual funds, stocks, bonds and real estate, but the UGMA doesn't allow for real estate assets. When a parent establishes a beneficiary for one of these investment account types, they can't transfer it to another beneficiary.
Saving and investing go hand in hand for those aspiring to build wealth, prepare for their futures, and improve their financial literacy. The main difference is the level of risk assumed when using a savings account versus an investment account. Savings accounts come with a low level of risk, so you can set aside money into one without feeling concern about whether the amount will remain relatively stable. The interest rate offered on a savings account may fluctuate with the economy and market conditions, but the funds in the account are insured up to $250,000.
When you're saving for the short term, putting money into a savings account is a good strategy. You can access the funds when you need them, or when you reach your goal and can make a big purchase. Having an emergency fund in a savings account can also protect you if you experience a life change that makes it difficult to support yourself or your family. It makes sense to use a lower-risk account when you're nearing retirement to prevent losing a significant portion of your funds to market fluctuations.
If you have an emergency fund in a savings account that will cover six to 12 months of living expenses and still have money left over, investing can be a good supplement to your financial strategy. Investing in stocks and bonds can offer higher returns than what's available through a savings account. Diversifying your investment portfolio with various types of investments can also boost your buying power and help you weather the risk of inflation. If you feel comfortable keeping your money tied up in an account for multiple years, opening an investment account may be the right step.
Alliant offers access to high-rate savings accounts for people of all ages and in all financial situations. Now that you know why it's worthwhile to keep at least some of your money in a savings account, learn more.
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