Saving and investing can mean the same thing to some people. There is a difference however, namely the types of accounts which are available and what areas should be focused on when getting started. Should you save first? Invest everything? Savings and investing only occur when you have a monthly or annual financial surplus.
Income – Expenses = Surplus
The definition of “saving” is: keep and store up for future use. As an example, when people save, they will keep putting money aside for roughly three years before spending it. During the saving process, your money is easily accessible, and is put away with little to no risk. Savings are usually spent in short periods of time on planned expenses (a trip, a new car, etc) or used to create an emergency fund. Before thinking about that trip that you want to save for, you should try to save six months worth of bills and expenses, so you can have financial security and a solid safety buffer. Savings are usually held in a checking account, savings account or a Tax Free Savings account.
Investing means the purchase of assets or items with the hope that the value will appreciate or provide profit and income. There is always a risk when investing. The lower the risk, the lower the projected return. As risk increases, the higher potential returns can be. The reason people invest is to try to grow their money faster than simply leaving it in the bank. The increase in investment value is referred to as Return on Investment (ROI). ROI comes in the form of interest, dividend, or increase in the value of the investment. Some examples of investments are buying real estate, an education, mutual funds, stocks, bonds, GIC’s. Your investments may not always be liquid meaning that you may not be able to cash in your investments at a moment’s notice. Liquidity or access to your money is an element of risk. When you invest you are saving for your long term goals. Since returns are a function of risk, understanding your investment objectives and risk tolerance is important. Taking this into consideration, a balanced investor should hope to see a steady increase in growth over five or more years.
People struggle with knowing when to save and when to invest. At the end of the day, it is up to your own comfort level. A good rule to follow is to save a minimum of 10% between your savings and investing, every paycheque. The split between the 10% that you invest and save will vary, given where you stand financially. It is always important to keep some sort of balance, but until you save up your six month emergency fund your main focus should be on that. A good balance would be to use 60% of your surplus towards saving, and the other 40% for investing. Once you have your emergency fund covered, you should scale back on your short term/ emergency savings and add to your longer term investing.
After you have your six month emergency fund it is really dependent on what your next plans are. If you are planning a trip or making a large purchase in the near future, you should be saving 20% while investing the other 80%, but if you don’t have immediate plans, why not invest ALL 100%? Once you have your six month emergency fund, you should not feel any real stress to save. Focus on growing your investments to grow your portfolio and help yourself in retirement.
The 8th Wonder of the World
Albert Einstein discovered what he would call the greatest mathematical discovery ever, (even greater than E=MC2) and considered it the 8th wonder of the world! That discovery is called “The Rule of 72’. The rule of 72 is a way of determining how long it would take for you to double your money/ investment with a fixed compound rate. It will shock you how simple this calculation actually is. Just take 72 and divide it by your expected return on investment in order to see how many years it will take to double.
If you have $10,000 with a fixed compounding interest of 5% how long would it take to double your money?
Ans: 72 / Interest = Time to Double
72 / 5 = 14.4
Therefore it would take you 14.4 years to double your investment from $10,000 to $20,000.
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