I was talking to a friend at the park the other week about Retirement and she was confused:
“I’ve been saving for retirement my entire career. (10+ years) Why is it that I just don’t feel like I have nearly enough to ever retire?”
“Wait, you mean investing right? What are you invested in?” I asked.
“Yeah, yeah. Investing. Saving. Whatever.” She replied. “I put money into my 401k at work and into my savings account every month, but the balance just doesn’t seem to be going up like everyone always talks about. Last year, all those ‘crazy market gains’ didn’t do anything for me!”
Oh dear, I thought. “You do realize there’s a big difference between saving vs investing for retirement right?”
Turns out, she did not realize. So I tried to explain.
Save For Retirement
When saving, you are putting money away for the future! Great Job!
What Savings Are
Savings are usually liquid money in a savings account. Money that can be easily cashed out to purchase things with minimal time or effort and little to no possibility of loss. (Thank your FDIC insurance!)
Savings often include:
- An Emergency Fund
- Expected Expenses Funds (Hello, vacation and car repair funds)
- Savings for a home/car purchase in the near future (less than 5 years)
Savings are usually put in regular ol’ savings accounts in a bank that (currently) receives less than 1% interest.
(Other options might be a CD or Money Market account)
Their whole purpose is to be safe and accessible if/when you need it in the future.
Savings create a safety net for you and your family.
If you lose a job, have an accident, the roof caves in, or whatever else, your savings are ready to deploy.
They save you from unnecessary debt, uncertainty, or other pain and suffering.
Savings earn minimal interest, but the loss of growth is worth the safety net. (Where to Put Your Savings)
What Savings Are Not
Savings are not a place to build a retirement portfolio for your future.
Unless you are within 5 or so years to retirement, you are most likely in the accumulation phase. This means you should be stashing away as much as possible during your working years while choosing the best investments to let your money grow!
Savings in a bank account earn minimal interest, (less than 1%) allowing inflation to eat away at it every year.
With the average inflation rate of 3% (7+% this past year) every year your money sits in a bank account, its value actually goes down.
So if you think you are going to save your way to retirement, without ever investing, you are setting yourself up for a hard ride.
Invest For Retirement
When investing, you are allowing your money to work for you! It takes a few more dips and curves than savings, but the growth potential is worth it!
What Investing Is
When you invest in stocks, you are essentially buying small parts of a company, or with index funds, companie(s), that you believe will grow.
By owning a small portion of the company, the value of your investment grows when the company grows.
If you were to purchase a piece of a Total Stock Market Index (like VTSAX or VTI) you are purchasing a small portion of every single publicly owned company in the U.S.A.
As the entire market goes up or down, so do your investments.
Over the last 50+ years, the average annual growth for the total stock market has been about 10% a year.
Remember, this is the average. Some years, it has actually gone down and some years, like 2021, it can grow as much as 25% or more!
There are also other investments besides stocks to diversify and grow your portfolio including things like:
- Bonds (Loans to companies or governments)
- REITs (Real Estate Investment Trusts)
- Real Estate Properties (Rentals, Commercial Buildings, etc)
- Small Businesses
- Much More
Investing Math
When you invest for retirement, you are usually investing for 10+ years. Over the years, those investments will dip and grow, but on average, you can expect the stock market to grow at about a 10% rate.
This 10% growth rate allows your money to keep up, and even beat inflation. (10% average investment return less 3% average inflation, leaves you with an average 7% growth rate!)
10% average growth – 3% average inflation = 7% average overall growth
With that 7% average growth, all those dollars you are putting away every month for retirement are able to compound on themselves.
Every dollar earned in interest this year makes even more dollars for you next year. And next year, and the next…
Until you finally reach Financial Independence!
Once you hit FI, you can quit that job you hate and decide what you want to do with your time.
Or keep that job you love but work different hours or do pro bono projects.
What Investing Is Not
Investments are not get-rich-quick schemes. They require a little bit of research and time to grow.
Buying into the “Hot New Company/NFT/Crypto” your friend Joe told you about is not what I’d call investing necessarily. It’s too speculative.
There is no guarantee that you chose the right Hot New Thing. And more often than not, by the time you hear about it, it’s old news and most of the potential growth has already been claimed.
There is also Day Trading. This requires a ton of research and practice to become profitable. Very few people are willing or able to put in the work necessary to become successful day traders.
I much prefer to be a lazy investor.
Follow my Super Simple Investing Strategy for Beginners and you should be on your way to a financially healthy retirement.
So, What Should I Do?
After going over the differences between Saving vs Investing with my friend, she asked “So, what should I do?”
- If you already have a 401k/IRA that you’ve been contributing to, go to your HR department at work/brokerage and make sure you are actually investing in something! Not just filling up a money market account.
- So many people, like my friend, spend years dutifully putting money into a retirement account only to learn they were never actually invested in anything! It was essentially just a big savings account growing at less than 1%, so frustrating.
- If you do not have a retirement account at all, go open one and start investing!
- Either talk to your HR department about an employer-sponsored program or open your own IRA (Roth or Traditional)
- Make your contributions automatic
- If you rely on yourself remembering to put your “extra money” in your retirement account each month, I can guarantee you will “forget” or “not have extra money” more often than not. Make it automatic and contribute every month.
Wrap-Up
When you’re trying to build a nest egg for retirement, saving vs investing can make a big difference!
As you get closer to retirement age, it makes sense to build a bigger liquid cash reserve, because you will rely on that cash to live off of if the market takes a nosedive for a bit.
But if you are still some years out, make sure you are investing and making your money work for you!
Don’t worry about finding the perfect stock or creating the ideal portfolio. Just get into a target-date fund if you need to. The main task is to get investing!
Be consistent, dollar cost average* every month, and let it grow!
What do you think? Do you know anyone who found out years later they were contributing to a retirement account without actually being invested? Did you make that mistake?
Leave a comment below and join the conversation!
*Dollar Cost Averaging is buying at the same time, every month or every check no matter what the market is doing.
My best friend just found out her old 401k that was turned into an IRA after leaving the company was never reinvested in anything. It sat as a money market account for 3 years. She recently realized and got it invested. It was very disheartening to know she lost those years of growth.