The 5 Pillars of Personal Finance, Pillar #2: Save & Invest
Personal finance is a big topic, and it can be hard to know where to start when you're new to it. But in order to have a healthy financial life, you don't have to know everything. There are 5 pillars of personal finance, and if you understand and implement them, you'll have a solid base for your financial life. The 5 pillars of personal finance are:
Earn
Save and invest
Protect
Spend
Borrow
Today we explore the second pillar, save and invest.
A distinction
The terms saving and investing are often used interchangeably in the world of personal finance, but they are two distinct things. Saving means cash, the money in your checking account, your savings account, your emergency fund. Savings is cash that you can access immediately, and if it's earning anything on it, it's typically a very small amount of interest like you get in your savings account.
Investing is "the process of buying assets that (hopefully) increase in value over time and provide returns in the form of income payments or capital gains."
Examples of investments include:
Stocks
Bonds
Real estate
Mutual funds
ETFs (Exchange Traded Funds)
CDs (Certificates of Deposit)
Saving and investing are equally important, but as you can see, they are not the same thing.
Your timeline
Should you save or invest? Ideally, both, but it depends on your plans for the money. When it comes to money, there are three timelines:
Short-term: Fewer than five years. Short-term money should not be invested. Five years may not be long enough for investments to recover if there is a downturn in the stock market. Examples of short-term goals might be saving for a vacation or wedding.
Medium-term: Five to ten years. Medium-term money can be invested but in lower-risk investments. Examples of medium-term goals can include investing for a downpayment on a home or paying for a child's educational expenses.
Long-term: 11+ years. Long-term money should be invested in higher-risk investments as it has time to recover from adverse market conditions. Some long-term goals include investing to buy a second home as a rental property and
Saving
The first order of business is to build an emergency fund. Ideally, your fund will contain three to nine months' worth of essential expenses, depending on your situation.
If you're single and don't have any dependents, and have a high degree of job security, you can aim for the lower end of that. If you have dependents or don't have job security, aim for the higher end. If you have "bad" debt (high-interest debt like credit cards or payday loans), paying that off is your priority but aim to accumulate a $1,000 emergency fund. Even a small emergency fund can help prevent additional high-interest debt and cover many of life's unexpected, urgent expenses.
When it comes to saving money, every penny counts, but if you want to save real money, focus on the right areas. Will clipping coupons save money? Yes, but a few dollars a week isn't that impactful to your financial situation. Housing is the most significant monthly expense for most people, so keeping housing expenses at 30% of net income) or lower is recommended.
Interest is another huge expense. Not all interest can be avoided if you take out a loan for a vehicle or a home, for example. But that type of interest can be minimized with a healthy credit score because the better your score, the better interest rates you'll be offered when borrowing money. Let's look at an example.
You buy a home for $100,000 with a 20% downpayment, so you borrow $80,000 with a 30-year term at:
6% interest
7% interest
The interest on the loans is:
6%: $92,670.55
7%: $111,607.12
So including the principal of $80,000, the total cost of the loan was:
6%: $172,670.55
7%: $191,607.12
Just that 1% difference in interest would save you nearly $20,000 over the life of the loan.
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Investing
Most of us will not inherit a fortune or win the lottery. And for many, their job doesn't pay enough to make them rich. There are exceptions, but in most cases, just saving money will not make you rich. If you want to grow your wealth, you must invest.
Consider this; If you had purchased $1,000 in Apple stock in 2003, 20 years ago, it would, at the time of writing, be worth $589,234.97. You simply purchased that stock and did nothing else, and you made well over half a million dollars.
The stock market took a lot of hits over those 20 years, including the impact of the 2008-2009 financial crisis and the pandemic, but it always came back stronger than before. The risk to your money isn't ups and downs in the stock market; it's not investing, as the example below will show.
How much would you have if you put that $1,000 into a savings account and let it sit for 20 years? Currently, the average interest rate a savings account pays is 0.39%. So in 20 years, we would have a whopping $1,081. We made less than $100.
There is no way around it; if you want to build wealth, you must invest. Investing doesn't have to be complicated, and you don't have to work on Wall Street to be a successful investor. Things like ETFs, mutual funds, and 401(k)s have made investing easy and accessible for everyone.
How Upwardli can help
Upwardli was created to help those new to credit, including immigrants new to the country and the U.S. financial system, build credit quickly and easily. You'll be instantly pre-approved with no credit check or deposit. Each Upwardli account includes an unsecured line of credit to help build your credit quickly, and we report your progress to the credit bureaus.
In our next article, we'll discuss the third pillar of personal finance, protect.