When it comes to managing your money, there’s a season for everything: there’s a time to spend, a time to invest, and a time to save.
As you consider the full picture of your financial life, three important questions arise:
- What financial season are you in today?
- What financial goals are you pursuing for tomorrow?
- Which strategy is best for you right now: saving vs. investing?
If you recently immigrated to the United States, it may seem impossible to answer those questions with true confidence.
Here’s the good news: investing and saving strategies are always helpful as you seek to build your version of the American Dream. No matter your age, career, socioeconomic level, or immigration status, you should know that there’s a strategy for everyone.
To help organize this rather expansive topic, we divided this article into three main parts.
After a short explainer on the tenets of “saving vs. investing,” Part 1 will cover when to invest, Part 2 will cover when to save, and finally, Part 3 will cover how to save.
Let’s dive in!
Key Article Takeaways
Prefer the shorter version? No problem.
Here’s the article summary:
- If you need cash in the near term, prioritize saving over investing.
- If you’re thinking about buying stocks, first set a budget, tackle debts, and establish an emergency fund.
- If you invest, start slow, be patient, and favor long-term stability over short term success.
- If your employer offers a 401(k) match, take full advantage of it.
Saving vs. Investing Explained
Though the terms are often used interchangeably, saving and investing are two very different strategies.
When you save, you store your money in a bank account with relatively low returns and equally low levels of risk.
By contrast, investing exposes you to higher levels of risk with the potential for outsized returns.
That’s true whether you invest in the stock market, in cryptocurrency, in real estate, or in any other “alternative” investment.
As fundamentally different as saving and investing may be, they’re still united in one key area: they’re both strategies that can help you build wealth over an extended period of time.
The question is: which path should you choose?
Deciding on one, the other, or a combination of the two strategies will depend on your unique financial situation.
Part 1: When to Invest
Investing is a long-term endeavor defined by volatility, especially when it comes to the stock market. In other words, the stock market is like a financial rollercoaster. Some parts of the ride are thrilling, while others are disconcerting (to put it mildly).
For most Americans, therefore, investing isn’t about turning a short-term profit. Instead, it’s about building a savings “nest-egg” to enjoy throughout retirement.
There’s a good reason for that.
Historically, the stock market averages a return of over 10%, and it consistently beats inflation by about 7%. In 2022, where commodity prices are surging and the dollar’s purchasing power is declining, investing may seem like an attractive option for your discretionary income.
But hang on! Before you put your money in the market, it’s smart to keep a few things in mind. For starters, remember that the stock market is highly volatile. While gains are possible, losses are inevitable.
In just the last two years, we’ve seen both the highest highs and the lowest lows. While 2020 and 2021 were banner years for investors, 2022 is widely considered one of the worst starts in recent history.
Such dramatic swings are par for the course.
Retirement Accounts: Explained
In the world of investing, you’ll often hear about things like “IRAs” and “Roth IRAs.”
Though the terminology may sound complex, it’s pretty straightforward: an individual retirement account (IRA) is simply a tax-advantaged investment account. In other words, you’ll never have to worry about getting taxed on trades completed in an IRA — so long as you leave the money in your account.
Once you consider withdrawing your money, however, things can get a little tricky (as we’ll discuss in a bit).
For now, there are three types of retirement accounts to consider:
- Traditional IRA: Contributions to a traditional IRA are “tax-deductible,” which means that the amount you contribute directly reduces your taxable income.
For example, if you make $50,000 a year and put $5,000 from your earnings into a traditional IRA, your taxable income would then be $45,000.
- Roth IRA: Unlike a traditional IRA, contributions to a Roth IRA are not tax-deductible.
However, because you will have already paid tax on your contributions, your withdrawals will be 100% tax-free.
The question then becomes: would you rather pay taxes now, or pay them later?
Given the fact that tax rates will likely increase, it may make more sense to pay your taxes today — especially if your peak earning years are ahead of you.
- SEP IRA: If you’re self-employed, or a small-business owner, SEP IRAs are designed for you. As with a traditional retirement account, SEP IRAs contributions are tax-deductible and grow tax-deferred until withdrawal.
If you’re interested in opening an IRA, you can do it online through any broker, robo-advisor, or financial institution in a matter of minutes.
Example 1: The Value of Long-Term Investing
As we mentioned earlier, investing is a long-term game. Here’s a brief example to explain why that’s true:
Let’s say you’re 32 years old, and you invested $100 in a popular tech company through your IRA.
A year goes by, and the stock climbs to $150, at which point you decide to cash out.
The problem is, you’re only 33. If you withdraw money from your IRA before the age of 59 1/2, two things will happen:
- You’ll be taxed at your ordinary tax rate (depending on your current level of income).
- You’ll be assessed an additional 10% “early withdrawal” tax by the IRS.
So even though you made $50 on your initial $100 investment, you’ll