The Differences Between Savings Plans And Investment Plans
When it comes to managing money, it is important to have both a savings plan and an investment plan. Investment plans are for long-term goals such as retirement. A savings plan is for shorter-term goals such as building an emergency fund, saving for the purchase of a house, or setting aside money for having a child.
The importance of a savings plan
Everyone should have an emergency fund with enough money to pay your bills for from three to six months. As this is money you absolutely need access to during an emergency, such as being laid off from your job, this money should be held in a savings account. You don’t want this money invested and having to pull money out when the markets are down.
Another short-term saving need is for when you are planning to have a child. You should create a new baby budget to cover the large array of costs you will incur. This includes food, diapers, toys, clothes, and so on. Having this money already on hand will go away toward keeping stress level downs. Make sure you prepare a list of questions that help you deriving conclusions about whether or not you’re financially prepared to bring a child into your life.
What an investment plan looks like
An investment plan is for your long-term financial goals with the biggest one being your retirement. This money is invested in a mix of stocks and bonds according to both your tolerance for risk and you need to take the risk. In general, as you get older your investment portfolio should start to become more conservative with a larger percentage dedicated to bonds which are not as volatile as the stock market.
You should start investing for retirement as early as possible, as Lifehack has illustrated in an illuminating chart. The reason why you want to get started early is because of the power of compounding interest. The money you put away early has 40 years to grow, compounding each dollar you put away into a much greater sum.
Someone that starts investing for retirement when they are young, as compared to getting started in their 30s or older, will have a much better nest egg built up for retirement. With a dedication to investing throughout the course of one’s career, a person can build up a seven-figure investment portfolio. They also don’t have to put as much money away each year versus someone who gets started later in life.
As the chart shows in this article, one person starts investing at age 19 while the other person starts at 27. They both put away $2000 a year. By the time they’re 65, the person who started earlier has $1,036,160 saved while the other person has just $883,185.
What you should be investing in
Your investment plan should include a mix of stocks and bonds. When you’re younger you can hold mostly stocks while once you get past the age of 50 most people should start to build up a larger percentage of bonds. Bonds keep the volatility of your financial portfolio lower and limit your downside when the markets tank as they do from time to time.
As for what stocks you should hold, you should be invested in a wide range of the publicly traded company. Nobody saving for retirement should be investing in single company stock. It’s far too dangerous and volatile to do so. You can lose literally everything when investing in a single company’s stock as the collapse of Enron in 2001 showed.
The importance of diversifying your stock portfolio is vital. You want to invest in as many publicly traded companies as possible so that you spread out your risk. It also makes investing far simpler as you can basically just buy a mutual fund such as one that invests in the entire US stock market and call it a day.
There are discussions of whether someone in the United States saving for retirement should have just US stocks or also invest in developed countries stock markets as well as emerging markets. By making your portfolio global you have even more diversity than just saving in US companies. Some people favour just investing in the S&P 500, such as Warren Buffet, while others say the science of investing shows that people should be more diversified than just that.
When it comes to bonds, intermediate terms bonds fit most people’s needs. They strike a good balance between short-term bonds, such as three years, and long-term bonds which are for 30 years. Investors should have a mix of treasury bonds, high-quality corporate bonds, and mortgage pass-through bonds. These should also be diversified by buying bond funds instead of individual bonds. You will never earn much on bonds but they are used because they reduce your portfolio’s volatility.