The terms “saving” and “investing” are thrown around a lot. We all know we should do both, but how are those actions different? We break down some of the most common options for “savers” and “investors.”
Saving money is something we’ve all been advised to do since grade school, and it’s no wonder why – saving is the simplest way to plan for large purchases and prepare for emergency expenses. Aside from keeping your money safe, there isn’t a lot that your savings can do to help build wealth. Anyone who relies on savings for financial growth should also be concerned about the rate of inflation, because the money sitting in savings accounts will likely have less buying power over time. In any case, cash reserves are very important to have, and can be established in several different ways.
Traditional, bank-sponsored savings accounts are the most common product people think of when discussing savings vehicles. Savings accounts offer low balance requirements, allow users to add and remove funds easily, and protect the money you place in them by the FDIC.
Money Market Accounts:
Money Market Accounts (MMA) are a type of savings account that typically earns a higher interest rate than traditional savings accounts, but may require larger minimum deposits and balances. These types of accounts are also FDIC insured up to a certain amount.
U.S. Treasuries include bills, bonds, or notes and are debt obligations of the U.S. government. When you purchase U.S. Securities, you are essentially lending money to the federal government for a specified period of time. U.S. Treasuries offer low minimum required deposits and come with fixed interest rates for up to 30 years. This savings option is not FDIC insured, but is backed by the full faith and credit of the U.S. government.
In a perfect world, all investments would have zero risk, guarantee high returns, and allow you to cash out penalty-free. But back here on earth, we know that expectation is unrealistic. The most common perception of investing is that it’s risky, and although investing your money is certainly more risky than saving it, all investments are not the same. Some offer the potential of high reward at high levels of risk, while others yield more modest growth with significantly less risk. We’ll break down the differences in some of the most common investment options.
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Publicly-traded stocks are the most common assets people think of when they hear the word “investing.” Stocks are growth investments that you buy in hopes of selling for a higher price at a later time; they are bought and sold on exchanges, the largest of which in the United States are the New York Stock Exchange (NYSE) and Nasdaq. The risk with stocks is that an increase in share price is never guaranteed when you buy, and you could lose money if you sell your shares during a market downturn for less than the original share purchase price. However, over time, the growth of all public stocks has consistently exceeded the rate of inflation in the United States.
Mutual Funds & Exchange-Traded Funds:
Mutual Funds and Exchange-Traded Funds (or ETFs) are a type of professionally managed investment that pools money from many people to invest in stocks, bonds, short-term money-market instruments, other securities or assets, or some combination of these. They also typically spread investments across a wide range of companies or industries in an attempt to diversify, lowering the risk to investors. Investors in mutual funds and ETFs can easily redeem their shares daily.
A bond is a debt security similar to a loan, with the investor serving as the bank. Investors may lend money to a government entity or corporation with the promise of being repaid on a certain maturity date, plus accrued interest. Bonds can be purchased from banks, brokers, and in the case of U.S. Treasury bonds, directly from the U.S. Treasury. The risk of corporate bonds ranges from low to high depending on the financial strength of the corporation issuing the bond.
Real Estate Investment Trusts (REITs):
As we’ve written before, REITs are companies that select, buy, and manage “real estate” (land and buildings). These companies are owned by shareholders and are required to distribute 90% of their taxable income back to their shareholders in the form of dividends. Although most REITs are publicly traded companies (making them similar investments to stocks), there are many REITs that are not publicly traded. Since traded REITs are bought and sold on exchanges, they offer investors daily liquidity, but suffer from the volatility of the stock market. Non-traded REITs are relatively illiquid in comparison, as shareholders may only have the option to sell their shares once per month or once per quarter. However, they are not directly affected by stock market volatility. Investors interested in putting money into real estate instead of publicly traded stocks may choose to invest in REITs for diversification, or to receive regular dividends. The dividend yields paid by REITs can often exceed the returns on dividend-paying stocks, too.
Saving is important to keep your money safe; you never know when an emergency or unanticipated expense can derail your long-term financial goals. But remember that the interest you earn on your savings is unlikely to keep up with inflation over time, making saving an inefficient way to grow your wealth. Most investment advisors would likely tell you to build a balanced portfolio that includes healthy saving habits and diversified investments across a number of assets to achieve long-term, consistent growth. And the most effective way to explore investment vehicles is by understanding the level of risk that each vehicle offers, and matching the risk you’re comfortable with to the return potential that may help you realize your financial goals. Investing can also seem more intimidating than it really is. Yes, there will always be the potential risk of loss, but there may be an even bigger potential for gain in the long run. And the sooner you start investing, the sooner you will be able to have your money work for you.
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Disclaimer: This information is for educational purposes only, and is not intended to represent investment, tax, or other financial advice. Please consult a qualified tax professional regarding the applicability of the above to your personal situation and the specific requirements and limitations of the above.
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