Saving money and investing money are two different things. So what’s the difference and what should you do first? There’s a clear answer.
Once your monthly income gets depleted by your monthly expenses, you have a decision to make with the money left over.
You can spend more of it on unnecessary purchases (your net worth goes backwards). You can save it (your net worth stays the same). Or you can invest it (your net worth grows).
Unfortunately, there’s only so much cash to go around. I’m positive you’re well aware.
From a strictly financial perspective it seems like the only logical choice is to invest it, right?
Not so fast my friend. Here’s why you need to first save money before you can invest, and not vice versa.
Step 1) Save Your Money First
To be honest, I’m not a big fan of saving money to save it. It’s too defensive for me. And no one has gotten wealthy from saving.
The sole purpose to save money first though is so you can cover your butt for short-term expenses and deploy this money in the future to make you more money (ie: invest in assets).
For the two reasons below, you need to first prioritize saving thousands of dollars before you jump on board the investing train. Don’t sprint before your money can walk.
Emergency expenses: Life is messy and out of our control more than we like. For example, you can’t control if your car’s radiator blows up one day or you get fired from your job because the economy hit a recession.
But you can control how prepared you are for these emergencies if you save 6 months of living expenses.
Let’s take the car example. If you invest all your extra money and then need a new radiator, it’s not an option to let it go unfixed. You need this car to get to work. So you’ll have to sell some of your investments to cover the tire cost.
That defeats the purpose of investing first and is a prime example why you need a stockpile of savings first.
You’ll save yourself the time, transaction fees, and potential early-withdrawal penalties by saving up for emergencies before investing.
Aiming for 6 months of living expenses gives you some breathing room from costly dilemmas.
Save for emergencies before you save for big purchases or invest.
Big purchases in 5 years or less: The second reason saving money initially needs to take priority over investing is for the high-ticket items that are sure to come.
This is what I mean by high-ticket items:
- New car
- Down payment on a house
- Wedding ring
- Across the country move
Imagine telling your girlfriend you’d love to propose but you don’t have the money to buy a ring because it’s all tied up in your stocks. You’d sound like a loser who could be facing single life soon.
Or imagine getting married but having to live in your parent’s place because you invested first and don’t have the savings for a down payment on a house.
That’s why you’ll help yourself by thinking about expensive costs coming up in the next 5 years and saving money for them.
Ideally you can both save for these purchases and invest at the same time. That’d be a huge win for your future self.
This will take some sacrifice if you’re used to a lavish lifestyle of ordering whatever you desire at restaurants and shopping like it’s a contest to run up the highest receipt.
Step 2) Invest To Build Wealth
Once you’re prepared for an emergency and upcoming high expenses, get your money working for you through investing.
Ideally you’re investing while you’re also saving for life’s big expensive moments, because this is how your net worth can double and triple within a short amount of years.
But if you haven’t been investing before and now you’ve saved enough money, it’s time you start owning assets that pay you.
While saving is necessary, investing is far more powerful and life-changing. And investing protects you against inflation eating away at your money.
Ok, what should you invest in?
For 99% of people—excluding the 1% who spend every waking second studying financial markets and have a knack for finding hidden value—I recommend you buy an index fund that matches the S&P 500.
This means you’re buying shares of Apple, Amazon, Facebook, Wal-Mart, and the other big buys across the United States. As they make money, they’ll pass dollars and dividends back to you.
Investing is not as complicated as you’d think when you understand the idea that you’re a part-owner of these giant, money-making companies.
Plus it gets better. Your money invested will make money off of itself as your accounts grow because of compound interest.
If you’re not familiar with compound interest, watch this Make $5 Million With Compound Interest.
It’s simple to me: Money either works for you or against you.
If you master money by saving and invest it, your life will be less stressful and you’ll gain freedom.
If you disrespect money by wasting it or not putting it out there to grow for you, you’ll always be in a financial bind without any hope of retiring.
Why make your life harder? Instead make it easier by:
- Saving 6 months of living expenses
- Saving for big purchases and or investing in index funds
- Continuing to put money in your index funds
Do that and feel confident because now you have a solid financial foundation in place. You can build on this going forward while not losing sleep at night.