People often talk about great investments they’ve made or the incredible investment return they’ve received.
Often, that’s for a good reason: Making good investment decisions is an important part of growing your wealth over time.
By intelligently putting your money at risk, you have the opportunity to outpace inflation and increase your wealth.
That’s important because if you only save money in cash, inflation will destroy the value of that cash over time.
But saving money is still a valuable action, and too often people try to leapfrog over the hard work of saving money and just try to rely on sky-high investment returns to make up the difference.
And that’s where we can get into a lot of trouble. We need to reframe how we think about investing and saving, because potential returns don’t mean much if you fail to build a savings habit first.
Taking No Action Yields No Results
The act of saving is completely different than the act of investing.
Saving simply means setting aside money that will be used later on, while investing means choosing to put your money at risk for the opportunity to generate a return on your investment (ROI).
With investing comes the risk of loss. That can be scary, especially for someone who doesn’t understand how much to invest or what to invest in.
It may feel like there’s no room for error, because if you get it wrong you risk losing your money.
And that’s the dilemma. Many people choose not to save anything because they don’t know what to invest in. They claim that they don’t know what they’re doing, and therefore, don’t even save money — let alone invest it.
This is also known as analysis paralysis. This is the state of over-analyzing or over-thinking a situation to the point that you never make a decision, or take action.
Doing nothing is often worse than getting it “wrong.”
Understanding the Power of Saving
Here’s the deal: Positive or negative investment returns don’t matter much if you don’t have money saved to invest in the first place.
A crazy 15% return on $0 is always going to be $0.
Here’s an example to help better illustrate how powerful saving can be:
Let’s say you invest $10,000 on January 1 of this year. You then receive a 7% return on that money over the next 12 months. You now have $10,700 in your account.
You saved $10,000 and you earned $700.
Most of the increase in the account over the year came from you saving $10,000. The $700 is only a small portion.
The investment return, although nice to have, didn’t really impact your account all that much.
Now, let’s say you’ve done a great job saving over your lifetime. You have $1,000,000 to invest. Again, you invest that money on January 1 and you earn 7% over the next 12 months.
By the end of the year you have $1,070,000 in your account. The investment return was $70,000.
That’s a lot more than your annual savings of $10,000. In fact, that’s 600% more.
Not saving because you don’t know how to invest is like trying to run a marathon after intentionally showing up to the starting line without shoes or water.
Don’t compartmentalize saving and investing. Saving and investing are two separate things — but they work best when combined.
Make Saving and Investing Work for You
When you put the emphasis on saving so that you do have something to invest, you have the opportunity to take advantage of compound returns over time.
Remember, the returns don’t matter all that much early on, so don’t worry about them to the point that you aren’t taking any action with saving at all.
The best way to financial success is to simply start today.