When planning how you want to manage your finances, one question you’ll likely ask yourself is whether you should focus on growing your savings or using your cash to invest. While investing can offer higher returns, savings provide a sense of security and stability. Given the different risks and returns, it can be difficult to decide which option you should be prioritizing.
Understand that you don’t necessarily have to make a choice between one or the other. Each has its role to play in your financial picture and having a combination of both cash in savings and in investments can certainly work to your benefit.
Once you understand the role each plays, you can be more confident in the decisions that you are making and what you prioritize.
First and foremost, when thinking about how to allocate your cash, ask yourself, do you have money outstanding on your credit cards or other high interest loans, or are you often finding yourself overdrawn? If the answer is yes to any of these questions, your priority should be focused on paying down that debt and building up some cash savings. It’s not smart to focus solely on investing if your high interest debt is ultimately costing you more than the returns you are likely to gain from investing.
Cash for the short term
If you’ve assessed your debt situation and you do have cash available to either save or invest, start thinking about the role each option plays in your financial plans.
Cash is a great source of meeting emergency and short-term needs, so if your car were to break down, or you have plans for a vacation in the coming months, having easy access to cash to pay for these things certainly makes sense. Furthermore, after the financial uncertainty we all experienced during the COVID lockdown, having access to cash in savings which can sustain you over a period of time is certainly a priority that we should all be planning for.
To create that cash buffer for shorter term needs and emergencies, consider opening a high interest savings account. Online savings accounts can be opened in a matter of minutes on your phone or at your desk. While the current interest rates on savings accounts aren’t going to make you a millionaire overnight, earning higher interest on your cash in an online savings account versus holding cash in a standard checking account does make sense. Particularly when its cash that you don’t need immediate access to.
It's not smart to focus on investing if your high interest debt is ultimately costing you more than the returns you are likely to gain from investing.
Invest for the longer term
As an investor, your aim is to make money by investing in companies, or financial instruments that you believe will do well for the long term. Investing provides you with a great form of passive income, which can be significant if the companies or funds you choose to invest in continue to turn a profit. Not only will you benefit from watching your initial cash investment grow over time, but you could also earn from the interest on your investments being reinvested and earning more interest on top of that - this is known as compounding interest.
1) Interest + 2) Reinvested = 3) Earning more interest on top
Whether you choose to invest in stocks, mutual funds, or exchange-traded funds (ETFs) if your investments pay dividends, you will also earn income every time the company or fund rewards its investors by paying out a dividend. A dividend is a percentage on the dollar which a company pays out to its investors when the company is profitable. It is like a “thank you” from the company to its investors which is paid out either monthly, quarterly or on an annual basis.
Of, course, your ability to earn through your investments will depend on the success of the financial instruments you invest in, so don’t forget that the market can be unpredictable, and returns aren't guaranteed. The value of investments can fluctuate, which means that their value can go up, but they and also go down. If the markets do well, your investment will grow, but you can also make a loss if the investments perform poorly over time.
Taking a longer-term view with your investments can be a great way of putting your money to work for you. Patience and knowledge are important factors in successful investing; be sure you understand the risks and consult with a qualified (independent / fiduciary) Financial Advisor.
Final thought...
Consider how easily you wish to be able to access your cash either in a savings or an
investment account. Savings accounts that require a notice period to take out your cash will pay a more attractive interest rate but may apply a withdrawal fee. An instant access account will allow you to access your funds when you need to but may pay less in interest. Investing through a brokerage account means you can also access your funds as and when you need to, however in order to sell a stock there needs to be a buyer on the other side, so your ability to sell out and access your cash will depend on how liquid the market is. A liquid market simply refers to how much buying and selling activity there is in the market and therefore how easy it is to sell out of your stock position.
Now armed with this information, you are better prepared to determine how you want to allocate your cash so that it works best for you. Rember, you don’t have to choose one option over the other. The key is to strike a balance between the two. Diversify your investment portfolio, and regularly monitor and adjust your finances based on life circumstances.
Your long term and short-term plans can comfortably co-exist with both savings and investments, putting you in a great position to get the most value out of your cash and grow your wealth.