When it comes to building wealth, the journey often starts with understanding the relationship between saving and investing. In this article, I will walk you through the key principles of saving and investing, how to balance the two, and how to design a portfolio that suits your financial goals. Whether you’re just starting or looking to refine your strategy, this guide will help you get on the right path toward financial growth.
Start Investing by saving
If you’re planning to start investing you first need to save. Setting aside a portion of your income consistently helps you build the financial base needed for future investments. Remember, you need money to make more money. By saving, you accumulate the capital necessary to start investing and growing your wealth.
How Much of Your Income Should You Save?
A common recommendation is to aim to save at least 20% of your income. This percentage may vary based on your financial goals, expenses, and income level. Saving is certainly easier when you have a higher income, but the principle of saving remains the same regardless of how much you earn.
As the saying goes, “There’s a limit to how much you can cut, but there’s no limit to how much money you can earn.” A higher income combined with a high savings rate allows you to build more capital, giving you more to invest and grow your wealth over time.
There’s a limit to how much you can cut, but there’s no limit to how much money you can earn.”
Where Should You Put Your Savings?
Instead of keeping your savings in a traditional bank savings account—which typically offers low returns that may not even keep up with inflation—consider more effective options.
One of the best alternatives is to open a Money Market Fund (MMF) account. Money Market Funds provide higher returns compared to savings accounts while maintaining liquidity, making them an ideal place to grow your savings as you prepare to invest.
A smart saving strategy involves splitting your savings into three different accounts, each with a specific purpose. This ensures you’re financially prepared for emergencies, upcoming expenses, and future investments.
- Emergency Fund
Your priority is to create an emergency fund. This money is only for true financial emergencies. Having an emergency fund allows you to avoid liquidating your investments when faced with unexpected expenses, which could disrupt your long-term growth.
Your emergency fund should cover at least 6 months’ worth of expenses. If you have dependents and rely on a single income source, it’s wise to aim for 9 months of coverage. - Short-Term Expenses Account
This account is for planned short-term expenses that you’ll need to cover shortly. Examples include school fees, holidays, or weddings. By setting aside money in advance for these events, you prevent dipping into your emergency fund or investment account. - Investing Account
Once your emergency fund is fully established and short-term expenses are accounted for, the remaining savings go into your investing account. This is the money you’ll use to build wealth through investments.
The contributions to these three accounts will shift over time. Once your emergency fund is complete and short-term expenses are covered, you can focus on allocating more towards your investing account, which helps accelerate your path toward financial independence.
Investing is for the rich; saving is for the poor.
If you plan to start investing with small amounts of money, your primary focus should be on saving more and growing your income first. Increasing your savings and boosting your earning potential takes precedence over worrying about investment returns at this stage.
In the short term, your investing returns won’t have as big an impact. The priority is to accumulate more money so that, in the future, you’ll have enough to invest meaningfully.
When Do You Shift the Focus from Saving to Investing?
The focus should shift from saving to investing when your Total Assets (money invested) x Expected Annual Return becomes greater than your Expected Savings.
In this case, your investments are now earning more than what you can save in a year. At this point, it makes sense to prioritize investing, as your returns will start to outpace your savings contributions, accelerating your wealth growth.
For example, if you have 100K invested with an annual return of 8%, you’ll earn 8K from your investments. But if your savings for that year only add up to 50K, it’s clear that your savings are still contributing more. However, once your investments grow and generate more than 50K a year, you should shift your focus and start investing, as it becomes the more powerful driver of your financial growth.
How Do You Design Your Portfolio?
When you start investing, it’s crucial to structure your portfolio with a focus on the following key principles:
- Security
Avoid investing in things you do not fully understand. Security is about preserving your initial capital, especially in the early stages of investing. Stick to investments you are knowledgeable about or can easily learn. - Diversification
In the beginning, concentrate your money on a few “sure bets”—investments with a solid track record and lower risk. As your wealth grows, you can diversify further. As Warren Buffett once said, “Wide diversification is only required when investors do not understand what they are doing.” Diversification is not how you build wealth; it’s how you preserve it. - Risk Appetite
Be mindful of your risk tolerance. Never invest more than you can afford to lose, and be aware of how much risk you’re willing to take on without causing unnecessary stress or financial strain. - Liquidity
Ensure your investments are liquid—meaning you can easily convert them into cash when needed. As the saying goes, “No matter how valuable an investment may be, it’s of no practical value unless it’s liquid when you need to cash out.” Having access to your money when necessary is just as important as the value of the investment itself.
For a practical guide on setting up an investment portfolio check out my article a simple 5-year plan for a profitable investment portfolio.
That’s a straightforward roadmap to help you get started with investing.
Please note: This illustration is intended for educational purposes. There are many assumptions made, and investing is not always as simple as it may seem. Market conditions, personal circumstances, and unexpected events can significantly impact your investment journey. Always do your research, consider seeking advice from financial professionals, and stay informed as you navigate the world of investing.
TL;DR
- Before investing, focus on saving.
- Avoid saving in bank savings accounts due to low returns.
- Initially, prioritize saving over investing.
- Split your savings into different accounts for specific purposes.
- Investing is for the rich, and saving is for the poor (start with saving first).
- Design your portfolio with security, diversification, risk appetite, and liquidity in mind.