Saving vs investing: Finding the perfect balance

Saving vs. investing money

A savings account is a safe place to park your money to achieve your short-term financial goals. By using a high-interest savings account or GIC that keeps up with inflation, you can maximize your returns while keeping your cash accessible in case you suddenly need it. A good rule is if you need to access your money in 1-3 years, then you should keep it in a safe and liquid savings account – not in the stock market.

That said, not many people have become rich by playing it safe with their money. If your timeframe is much longer (5 to 20 years), investing your money is a smart strategy. Rather than keeping pace with inflation, you have the potential to earn 6-10% per year over the long term by investing in a diversified portfolio of low-cost index funds or ETFs. If you’re saving to fund your retirement or a child’s education, investing can help you get there.

The bottom line? Investing is all about the trade-off between risk and reward. By accepting some short-term volatility with your investments, your expected long-term returns will be much higher than what you can earn in a savings account. If losing money makes you queasy, then you’ll want to add a healthy dose of bonds to your portfolio to prevent your stomach from churning when the markets start moving up and down like a roller coaster.

Should you save or invest?

At the heart of it, saving vs investing comes down to your time frame and risk tolerance. If you have short-term goals to fund – like buying a house or car – then you want that money to be absolutely secure and accessible. That means parking it in a savings account for when you need it.

In contrast, investing is for long-term goals, such as saving for retirement or a child’s education. You want to earn the highest rate of return possible for the risk you’re willing to take. That means investing in a mix of stocks and bonds (preferably by using low-cost index funds or ETFs) and holding on for years and even decades.

Ideally, everyone should have a mix of savings and investments. We need savings in the form of an emergency fund to cover unexpected bills or extended unemployment. And we need investments to help us earn inflation-beating returns to fund our retirement.

How much money should you save vs. invest?

It’s a good rule to put aside 3 to 6 months of expenses in cash. So, if your monthly expenses total $3,500, save roughly $10,500 in a high-interest savings account.

When it comes to investing, a simple rule is to invest 10% or more of your income for retirement. That means if you earn $50,000 per year, invest at least $5,000 annually into a TFSA or RRSP (or a combination of both).

If you start investing early (like in your 20s or early 30s), you can get away with investing a smaller percentage of your income. But try to increase that amount until you reach 10% or more. If you’re a late starter, you need to invest 15%-20% of your income for retirement. Another caveat: some experts say women need to invest more than men, in order to compensate for the “gender retirement gap.” So as a general rule, consider 10% the bare minimum.

Where to save your money

Setting aside money for emergencies and achieving short-term financial goals is a must. But where do you stow your money? A chequing account is great for everyday banking, but the interest earned is typically meagre and not suited to saving. Let’s look at the best options.

High-interest savings account

A high-interest savings account is a bank account where you can safely stash your cash and earn a completive pre-determined interest rate. Some (like EQ Bank) don’t charge any fees! However, there can be a trade-off: you’ll get an excellent interest rate, but in return, there may be restrictions on withdrawals, access, and minimum deposits. For example, if you make a withdrawal, your cash may not be accessible for 1-5 business days.

Ideally, you want to earn the highest return possible, so look for one of the best high-interest savings accounts in Canada that pays inflation-beating interest. For instance, the Savings Plus Account by EQ Bank offers an everyday interest rate is 2.50%* and doesn’t charge any everyday banking fees.

• Interest is calculated daily on the total closing balance and paid monthly. Rates are per annum and subject to change without notice.

READ MORE: EQ Bank review

Guaranteed Investment Certificate (GIC)

A GIC is one of the safest investments you can buy. Your principal investment and interest rate are guaranteed, which makes it the perfect place to put savings that you may need to cash out in the near future.

How it works: just deposit the money into an account and get an annual interest rate. Your investment is usually “locked-in” for anywhere between 30 days to 5 years and can be held in both non-registered and registered (TFSA, RRSP, RESP, RRIF) accounts. The best GIC rates in Canada range, so shop around before you buy.

READ MORE: Best GIC rates in Canada 2022 – Compare top GIC rates

Where to invest your money

Ready to invest your money for the long term, but not sure where to start? Investing is a three-step process:

1. Open an account (RRSP, TFSA, or non-registered) online at a discount brokerage or robo-advisor.
2. Fund your investment account by linking it to your bank account and transferring funds
3. Purchase your investments (we prefer low-cost index mutual funds or ETFs)

With the robo-advisor route, skip the last step because the robo-advisor will automatically purchase your investments for you. That’s right: in exchange for a management fee – typically 0.4% to 0.5% – a robo-advisor will provide you with a low-cost, globally diversified portfolio of ETFs and automatically invest, monitor, and re-balance your funds.

A robo-advisor is a great way to invest your money and take a hands-off approach to investing. Check out our complete guide to Canada’s robo-advisors or jump straight to Wealthsimple Invest, our top pick as Canada’s best robo-advisor. 

If you’d prefer a self-directed approach, then you’ll want to open an investment account online with a discount broker. We’ve compared Canada’s best discount brokerages in detail and determined that Questrade is your best bet for low-cost passive investing with ETFs.

Self-directed investing doesn’t need to be complicated. In fact, just select one of the best ETFs in Canada – an asset allocation ETF like Vanguard’s VBAL or VGRO, which invests in thousands of stocks and bonds from around the world for the low cost of just 0.25% MER.

Pros and cons

We’ve looked at different examples of saving vs investing. Here are the pros and cons of each approach:

Savings

• Higher rate of return than keeping cash in your chequing account

• Safe, secure, and liquid investment

• Best for short-term goals and emergency funds

• Can help curb spending behaviour by keeping funds out of your main account

• Interest rate will at best keep pace with inflation

• You’re not going to get rich parking your money in a savings account (at 2% interest it would take 36 years to double your money)

• Pay taxes on interest earned at your highest marginal rate (unless held within an RRSP or TFSA)

Investing

• Higher expected rate of return thanks to the equity risk premium

• Tax-sheltered options like RRSPs and TFSAs let your money grow and compound tax-free

• Can diversify and invest in a wide range of assets from around the globe

• Can be volatile in the short-term, with losses in the 40%-50% range in the historically worst years

• Investment fees are insidious and can make up one of the largest expenses in your budget if you use actively managed mutual funds

Frequently asked questions (FAQs)

Do you have to invest inside a RRSP or TFSA?

No, you don’t have to purchase stocks, bonds, or ETFs inside your registered accounts. Just open an RRSP or TFSA at your preferred bank or online brokerage and make a contribution to your account. The funds will be deposited as “cash.”

Next, you can purchase any number of products, including a simple savings account, GIC, or money market fund. You might want to keep some cash on the sidelines for any number of reasons but know that you can simply “save” inside either your RRSP or TFSA.

Is a savings account an investment?

Technically, a savings account is considered an investment. It’s a low-risk, highly liquid investment. You will earn a rate of return (interest rate) in exchange for parking your cash inside a savings account. That qualifies as an investment.

Is investing better than saving?

It depends on your goals. A savings account is a great place to stash away money for an emergency fund and/or to fund short-term goals, like buying a house or car. You’ll earn some interest and hopefully maintain your purchasing power over time.

In contrast, investing gives you the potential to earn a higher rate of return over the long-term. Sure, you’ll take some risk, but a properly diversified portfolio can earn you between 6% and 10% per year over a long time frame.

The bottom line

Are you a saver or an investor? Or both? The answer may depend on your age and stage of life. Your experiences may also play a role. Millennials who came of age during the global financial crisis may have a fear of investing in the stock market. On the flip side, if you started investing after the crash, say in 2009, you’ve seen nothing but strong market performance for the past decade or more.

The best way to decide between saving and investing is to prioritize your financial goals into short-and-long-term buckets and then decide which ones need to be safe, secure, and liquid, and which ones can afford to take on some market risk for the long term.

READ MORE: Best robo-advisors in Canada 2022: A complete guide to robo-investing