With prices rising across the board, Canadians are looking for ways to save. But when it comes to saving for your goals, there’s often more to it than putting aside money. If you want your money to keep up with inflation and help you achieve your goals faster, you may also consider investing your savings. Here’s how saving and investing differ.
What is saving?
Saving as a concept is simple: Take some of your paycheque and put it into a bank or investment account. While some people put whatever money is left over after paying their monthly expenses into an account, others automatically put a percentage of their dollars into savings before they have the chance to spend it. Still others make a lump sum savings contribution at the end of the year and a few find it difficult to establish a savings strategy at all.
If you really want to save, you’ll need to do a little planning.
What is a savings account and how does it work?
A savings account is a place to deposit money. It’s a straightforward financial tool that can be opened through a bank like TD. Generally, savings accounts will pay you a modest interest rate, although there are some savings accounts that offer higher interest rates provided savers keep a specified minimum balance in the account.
Benefits of saving money
Sadly, we all know money doesn’t grow on trees. If you want to achieve your goals, you have to save for them. Need a few reasons to get motivated? Here are a couple of key ones.
- Live your best life — Everyone has things they want to do in life. A dream vacation, a new home, a relaxing retirement — whatever your goal, at some point, you’re going to need your savings to help cover the bill. While it’s always a good idea to set aside money for your goals, this approach on its own may not be as effective over long periods as cash can lose value over time due to the ever-rising cost of living. That’s why saving is only one component of your financial plan — how you manage those savings is just as important. But more on that later.
- Cope with unplanned expenses — There will come a time when you’ll need to pay for something you didn’t plan for. If you want to minimize the disruption in your life, it can help to create an emergency fund for money you’ll only access in those unexpected situations — something like a job loss, unexpected home repairs or car troubles. Having an emergency fund in place may be a good way to keep your long-term goals on track.
Strategies to help accelerate your savings
- Set it and forget it — Saving is a habit. Without a system, it can be hard to remember to put money away on a regular basis. A better approach may be to automate your savings by setting up an automatic transfer to a savings account every time you get paid. You may not even notice the money coming out of your account, but you’ll be glad it did as you see your savings grow.
- Make a budget — If you want to save more, you may need to find ways to rein in your expenses. It sounds easy, but it can be hard to do. Start by trying to understand where your money is going. You might find some expenses you can cut along the way — money that you could redirect to savings. Then, create a budget for your remaining expenses.
- Tracking expenses — Building a budget is important, but if you want to make sure you’re sticking to the plan, you’ll have to track all your expenses. There are plenty of tools available online to help you see what you’re spending. At the end of each month, take a look at how your actual spending matches up with your budget and use that information to help improve your plan.
What is investing?
Saving is important, but it’s seldom enough to help you achieve your biggest goals. If saving is about putting aside your money, investing is about growing your money over time. There are many ways to invest, but most investors turn to investment vehicles like stocks, mutual funds, Exchange-Traded Funds, bonds and Guaranteed Investment Certificates (GICs).
While rising prices can erode the value of your savings over time, investing gives you a way to help ensure your dollars continue to grow to match — or exceed — the rate of inflation.
Benefits of investing
- Higher growth potential — While you can earn a little interest from a savings account, you’ll need to invest if you want to grow your money faster. For instance, since January 1985, the S&P/TSX Composite Index has climbed more than 700%, excluding dividends.1 Interest in a savings account can’t match that. Of course, while investing can yield higher returns, it comes with a risk of losing money. It’s important to consider your risk tolerance — your willingness to accept fluctuations in the value of your investments and your ability to weather any potential for financial loss — when choosing securities to invest in.
- Compounding — Making money from your savings is great. Making money off the money you made from your savings is even better. In simple terms, that describes compounding. When you earn interest on the interest you’ve already earned, you can magnify your returns over time. Try this compound interest calculator to see how your investments could grow.
- Help curb inflation — Inflation eats away at the value of your money. By investing your money instead of simply holding onto it, you may be able to keep pace or get ahead of inflation.
- Achieve long-term goals — Goals like saving up for a comfortable retirement take time. As an investor, you can use that time to your advantage through the power of compound growth. With compounded growth, your investment’s earnings are reinvested over time, which can increase the value of your money.
Managing your taxes
From a tax perspective, the accounts you use to invest may be as important as the types of investments you own. That’s because the money you earn from investing may be subject to tax. When you’re investing in a registered account like a Tax-Free Savings Account (TFSA), you don’t have to worry about Canadian taxes because growth in the account is tax-free. Other accounts, like the Registered Retirement Savings Plan (RRSP), can help you benefit from compounding since the gains inside an RRSP grow tax-free. You will, however, pay taxes on income when you withdraw money before retirement also.
Outside of a registered account, it’s important to know that different types of gains are treated differently by the tax code. For instance, capital gains, interest and dividends are all taxed at different rates.
Saving vs. investing: What is the difference?
Saving and investing work together to help you achieve your goals, but they work in different ways. While saving is about setting aside the money you have after covering your expenses, investing is about trying to grow that money to help you reach your goals faster.
- Short term vs. long term
When you’re saving for short-term goals, you may choose to focus on less-volatile investments because you’ll have less time to recover financially if your investments lose money. When you have a longer time horizon, you may choose to own riskier investments, like stocks, that have the potential to provide higher returns.
- Access to funds
Whether you are saving or investing, it’s always important to know what the money might be needed for. Savings are generally funds that you can access whenever you need to, whereas the money you invest may be harder to access. Depending on the investment, it can sometimes take time to withdraw money. In some cases, investment accounts and registered accounts, combined with potential tax complications, are designed to discourage you from withdrawing money on a regular basis.
There is little to no risk with a savings account, but there are risks with investments, such as a potential loss of some or all of the principal amount originally invested due to fluctuating returns or an economic downturn.
- Interest rates
One way to think of interest rates in regard to savings vs. investing is this: If your savings account has a lower interest rate than the rate of inflation, the real value your money will decrease over time. On the other hand, some types of investments such as fixed income vehicles like Guaranteed Investment Certificates (GICs) and bonds may offer a higher interest rate, so your money may have an opportunity to keep pace with inflation.
How does inflation impact savings and investing?
Inflation is the broad and persistent rise of prices for goods and services. In effect, it lowers purchasing power for both consumers and businesses. The Bank of Canada (BoC) aims to keep inflation at about 2% per year, which is the middle of its targeted range of 1%–3%. When inflation rises above that range (as it did following the emergence of the COVID-19 pandemic), higher day-to-day costs can make it harder to put money aside to save or invest.
Inflation and savings
Inflation decreases the value of your money. And as outlined above, if your savings account has a lower interest rate than inflation, the real value of your money diminishes.
Inflation and investing
Combatting inflation is one of the benefits of investing. By building a portfolio that uses different types of investment vehicles, you may have the opportunity to see your wealth grow at a pace that meets or exceeds inflation.
- “S&P/TSX Composite Index” MarketWatch, last modified May 15, 2023, https://www.marketwatch.com/investing/index/gsptse?countrycode=ca ↩