Why Investing Is Better Than Saving Your Money

For individuals seeking to grow their financial resources over time, understanding the distinction between saving and investing is fundamental. Saving typically involves placing funds in highly liquid and secure accounts, such as traditional bank savings accounts or Certificates of Deposit (CDs), where the primary goal is capital preservation. Investing, conversely, entails acquiring assets like stocks, bonds, or real estate with the expectation that their value will increase, generating returns or income over a longer period. This approach aims to build wealth beyond what basic saving can achieve, especially for long-term financial objectives.

Inflation’s Impact on Savings

Inflation represents the gradual rise in the prices of goods and services, which inherently diminishes the purchasing power of money over time. For instance, an average inflation rate of 2.6% to 2.7% has been observed over the last two decades in the U.S.. This means that money held in traditional savings vehicles, which typically offer low interest rates, may struggle to keep pace with the increasing cost of living. The national average interest rate for savings accounts currently hovers around 0.38% to 0.39% Annual Percentage Yield (APY), with some large banks offering as little as 0.01%.

Certificates of Deposit (CDs), which offer slightly higher but still modest rates, average around 1.76% for a one-year term. When these rates are compared against the persistent rate of inflation, the real value of savings can erode. Over an extended period, the money saved may buy less in the future than it does today, effectively losing purchasing power even if the numerical balance remains the same or grows minimally. This erosion highlights a significant challenge for relying solely on traditional savings for long-term financial goals.

How Investing Generates Returns

Investing provides mechanisms through which money can potentially grow at a rate that can outpace inflation, fostering real wealth accumulation. One primary mechanism is compounding, often described as earning “interest on interest.” This occurs when the returns generated by an investment are reinvested, leading to future returns being calculated on both the initial principal and the accumulated earnings. For example, if an investment earns 10% annually, the earnings from the first year are added to the principal, and the second year’s 10% return is calculated on this larger sum, leading to accelerated growth over time.

Another way investments generate returns is through capital appreciation, where the value of an asset increases over time. This is common with assets like stocks or real estate, where an investor can sell them for a higher price than what they initially paid. The S&P 500, a broad market index, has historically delivered an average annual return of approximately 10% to 10.4% since 1957, or about 6% to 7% after adjusting for inflation. This growth can be realized as long-term capital gains if the asset is held for over a year, which are subject to favorable tax rates of 0%, 15%, or 20% for most taxpayers in 2025, depending on income.

Investments can also generate returns through income generation, such as dividends from stocks or interest payments from bonds. Dividends are distributions of a company’s earnings to its shareholders, providing a regular income stream. For 2025, qualified dividends are taxed at similar preferential rates of 0%, 15%, or 20% based on the taxpayer’s income level. This combination of compounding, capital appreciation, and income generation allows invested capital to potentially grow significantly more than money simply held in traditional savings accounts.

Navigating Investment Risk and Reward

Investing inherently involves a relationship between risk and potential reward; generally, higher potential returns are associated with higher levels of risk. Market fluctuations are a normal part of investing, meaning the value of investments can rise and fall, and there is a possibility of losing money. Unlike savings accounts, which are typically insured by the Federal Deposit Insurance Corporation (FDIC) up to $250,000 per depositor, per insured bank, investment values are not guaranteed.

A strategy to manage investment risk without eliminating it entirely is diversification. Diversification involves spreading investments across various asset classes, industries, or geographic regions to reduce the impact of poor performance from any single investment. For example, a portfolio might include a mix of stocks, bonds, and other assets, as these different types of investments may react differently to market conditions. While diversification helps mitigate specific risks associated with individual assets, it does not protect against overall market risk, which affects all investments to some degree. Understanding one’s personal tolerance for market volatility is an important component of developing an investment approach.

First Steps to Investing

Embarking on an investment journey begins with establishing clear financial objectives. Defining what one is investing for, such as retirement, a down payment on a home, or funding education, helps shape the investment strategy. Similarly, understanding the time horizon, or the length of time funds will be invested, influences the types of investments suitable for those goals. Longer time horizons generally allow for greater exposure to growth-oriented assets with higher short-term volatility.

Starting with manageable amounts and contributing consistently is a practical approach often referred to as dollar-cost averaging. This strategy involves investing a fixed amount of money at regular intervals, regardless of market fluctuations, which can help mitigate the risk of investing a lump sum at an unfavorable market peak. Many individuals begin by choosing an appropriate investment account, such as a brokerage account for general investing or retirement accounts like Traditional IRAs or Roth IRAs, or employer-sponsored 401(k)s. For 2025, the employee contribution limit for 401(k)s is $23,500, with an additional $7,500 catch-up contribution for those age 50 and over. IRA contribution limits for 2025 are $7,000, with an additional $1,000 catch-up for those age 50 and over.