What’s the difference between saving and investing? The terms saving and investing are often used interchangeably, but there’s a difference. See Smart About Money, from the National Endowment for Financial Planning:
- Savingis setting aside money you don’t spend now for emergencies or for a future purchase. It’s money you want to be able to access quickly, with little or no risk, and with the least amount of taxes. Financial institutions offer a number of different savings options.
- Investingis buying assets such as stocks, bonds, mutual funds or real estate with the expectation that your investment will make money for you. Investments usually are selected to achieve long-term goals. Generally speaking, investments can be categorized as income investments or growth investments.
Saving, from the Concise Encyclopedia of Economics
Saving means different things to different people. To some it means putting money in the bank. To others it means buying stocks or contributing to a pension plan. But to economists, saving means only one thing—consuming less in the present in order to consume more in the future.
An easy way to understand the economist’s view of saving—and its importance for economic growth—is to consider an economy in which there is a single commodity, say, corn. The amount of corn on hand at any point in time can either be consumed (literally gobbled up) or saved. Any corn that is saved is immediately planted (invested), yielding more corn in the future. Hence, saving adds to the stock of corn in the ground, or in economic jargon, the stock of capital. The greater the stock of capital, the greater the amount of future corn, which can, in turn, either be consumed or saved….
Investment, from the Concise Encyclopedia of Economics
Although in general parlance investment may connote many types of economic activity, economists normally use the term to describe the purchase of durable goods by households, businesses, and governments. Private (nongovernmental) investment is commonly divided into three broad categories: residential investment, which accounts for about a quarter of all private investment (25.7 percent in 1990); nonresidential, or business, fixed investment, which accounts for most of the remainder; and inventory investment, which is small but volatile. Indeed, inventory investment is often negative (it was in 1990, and in three years during the eighties). Business fixed investment, in turn, is composed of equipment and nonresidential structures. Equipment now makes up over three-quarters of business investment….
Understand the power of compounding. Compound Interest, from our College Topics Guide.
When you borrow or lend money, you pay or receive interest.Compound interestis paid on the original principalandon the accumulated past interest.
The Miracle of Compound Returns, from the Marginal Revolution University “Money Skills” course.
Diversification: How to Spread It Around, at SocialStudiesforKids.com.
Diversification can best be described by the following phrase: “Don’t put all your eggs in one basket.”
That means several things, depending on what part of economics we’re discussing. In every case, though, it means to spread out your money or your time or your other resources….
See also: What is Diversification? at BizBasics:
In the News and Examples
David R. Henderson, In Praise of Debt, at Econlib, June 2016.
If I were to put it in Polonius’s terms, I would say it this way: “Botha borrower and a lender be.” That is, at some points in your life, it makes sense to borrow, and at other points, it makes sense to lend. In this article, I focus on borrowing. What follows is my case for debt.
Chris Blattman on Cash, Poverty, and Development, EconTalk podcast, July 21, 2014.
Chris Blattmanof Columbia University talks to EconTalk hostRuss Robertsabout a radical approach to fighting poverty in desperately poor countries: giving cash to aid recipients and allowing them to spend it as they please. Blattman shares his research and cautious optimism about giving cash and discusses how infusions of cash affect growth, educational outcomes, and political behavior (including violence). The conversation concludes with a discussion of the limits of aid and the some of the moral issues facing aid activists and researchers.
A Little History: Primary Sources and References
Harry Markowitz, from theConcise Encyclopedia of Economics
In the early 1950s Markowitz developed portfolio theory, which looks at howinvestmentreturns can be optimized. Economists had long understood the common sense of diversifying a portfolio; the expression “don’t put all your eggs in one basket” is certainly not new. But Markowitz showed how to measure the risk of various securities and how to combine them in a portfolio to get the maximum return for a given risk.
Franco Modigliani, from the Concise Encyclopedia of Economics
Franco Modigliani, an American born in Italy, won the 1985 Nobel Prize for two contributions. The first was “his analysis of the behavior of household savers.” In the early fifties Modigliani, trying to improve on Keynes’s consumption function, introduced his “life cycle” model of consumption. The basic idea was common sense, but no less powerful for that reason. Most people, he claimed, want to have a fairly stable level of consumption. If their income is low this year, for example, but expected to be high next year, they do not want to live like paupers this year and princes next. So in high-income years, Modigliani argued, people save. They spend more than their income (dissave) in low-income years. Because income begins low for young adults just starting out, then increases in the middle years, and declines on retirement, said Modigliani, young people borrow to spend more than their income, middle-aged people save a lot, and old people run down their savings….
Advanced Resources
Setting Financial Goals, a Month-by-Month plan from the Smart About Money, the National Endowment for Financial Education.
Can You Beat the Market? from the Marginal Revolution University “Money Skills” course.
Related Topics
Money Management and Budgeting
Financial Markets
Real vs. Nominal
GDP
Human Capital
Insurance
Risk and Return
As someone deeply immersed in the realm of personal finance and economics, it's clear to me that the distinction between saving and investing is fundamental to understanding how to manage one's finances effectively. Allow me to elaborate on each concept and provide insights into related terms and theories mentioned in the article you've provided.
Saving: Saving involves setting aside money that you don't currently spend for various purposes, such as emergencies or future purchases. It's essentially preserving funds for short to medium-term needs, often with an emphasis on accessibility, low risk, and minimal taxation. Savings can take different forms, including traditional savings accounts, certificates of deposit (CDs), or money market accounts. Economically speaking, saving is about consuming less in the present to have more to consume in the future, thus contributing to the accumulation of capital and fostering economic growth.
Investing: Investing, on the other hand, entails putting money into assets like stocks, bonds, mutual funds, or real estate with the expectation of generating a return over time. Unlike saving, which focuses on preserving capital, investing aims to grow wealth through capital appreciation, dividends, or interest income. Investments are typically selected based on long-term financial goals and risk tolerance. They can be categorized into income investments, which provide regular income, and growth investments, which aim for capital appreciation.
Compound Interest: Compound interest is a powerful concept in finance, where interest is not only earned on the initial principal but also on the accumulated interest from previous periods. This compounding effect allows investments to grow exponentially over time, highlighting the importance of starting early and allowing investments to compound over the long term.
Diversification: Diversification is a strategy aimed at spreading investment risk by allocating capital across different assets or asset classes. By not putting "all your eggs in one basket," investors can reduce the impact of poor performance in any single investment on their overall portfolio. Diversification can be achieved through asset allocation, investing in different industries, geographic regions, or types of securities.
Debt and Borrowing: While the article doesn't directly address debt, it's worth noting the role of borrowing in personal finance. Responsible borrowing can be a strategic tool for achieving financial goals, such as purchasing a home or financing education. However, it's essential to manage debt wisely, considering factors like interest rates, repayment terms, and overall debt levels.
Economic Growth and Savings-Investment Relationship: The article touches upon the relationship between saving, investment, and economic growth, emphasizing how saving contributes to the accumulation of capital, which in turn fuels future production and consumption. This underscores the importance of savings rates in driving long-term economic prosperity.
Financial Planning and Goal Setting: Setting financial goals and developing a comprehensive plan to achieve them is crucial for effective money management. This involves assessing current financial status, identifying objectives, and implementing strategies like budgeting, saving, investing, and risk management to attain those goals over time.
Market Efficiency and Active Management: The article indirectly touches on the debate surrounding market efficiency and the possibility of beating the market through active management. While some investors aim to outperform benchmarks through stock picking or market timing, others advocate for passive investing strategies like index funds, which aim to match market returns at a lower cost.
Additional Concepts and Resources: The article references various other topics related to personal finance and economics, including financial markets, GDP, human capital, insurance, and risk-return trade-offs. These concepts are integral to understanding the broader landscape of financial decision-making and economic principles.
In essence, distinguishing between saving and investing, understanding the power of compounding, embracing diversification, and incorporating debt strategically are essential elements of sound financial management. Moreover, aligning financial decisions with long-term goals and leveraging economic principles can lead to more informed and effective financial planning strategies.
