I’ve said before that I’ve always been a saver, but only recently I’ve started become an investor outside of retirement accounts (IRAs and 401ks). Saving and investing are often used interchangeably, but I get a lot of questions from inexperienced investors on how the two should fit into their lives. Whether or not you hope to retire young/early, everyone should be investing outside of retirement accounts. I’ll try to differentiate the two terms here and give my opinion of when and how much to use each.

Saving

For those not used to investing in the market, Saving is typically associated with putting money in a Savings Account (or maybe just keeping more in checking). Having a chunk of money in a Savings Account is not a bad idea; although my blog doesn’t talk much about it. It’s pros and cons time:

Pros: Liquid (you can get the money immediately if you need it), won’t lose any value when the market drops, earns a little bit of interest, no maintenance, low or no minimum balance, you can open it wherever you keep your checking account, not complicated.

Cons: Low earnings rate, tax-inefficient, interest rates are lower than inflation rate, easy to spend when sitting right next to your checking account.

Investing

Pros: High earning potential, liquid, tax-efficient, safe over long investment periods, easy to set it and forget it, compound interest, easiest way to get rich.

Cons: Can lose value, can be hard to know where to start, lots of options can make it feel complicated, investment firms try to complicate things, may have high minimum balances, may be lots of fees, lots of people confuse investing with gambling.

When to stop saving and start investing

Here’s my 2¢. Save 3-6 months of your spending, then invest ALL the rest! So your expenses (housing, food, transportation, cell phone, insurance, and other necessities) cost you $4k per month. Put $12,000 to $24,000 in a savings account. Then once you hit your number, EVERYTHING ELSE should go into investments. Those investments can be in the form of IRA or taxable brokerage accounts. 3-6 months may sound like a big range, but you can probably whittle it down to what’s right for you by considering a few things:

• How stable is my income? If you have dual income and no kids like my wife and I, you can probably lean closer to the 3 months. If one of you gets canned, you probably won’t have to really dip into savings. If you are a 100% commissioned salesman, and have a family of 5 that’s all leaning on your income, you may want to lean closer to the 6 months.
• How stable are my living expenses? If you are expecting a new baby, know you have big medical bills coming up, or expect to make a home purchase in the next couple months, you may want to lean closer to 6 months of cash savings.
• Remember that you can ALWAYS sell and withdrawal from your taxable brokerage account. That money is very liquid. I tell most of my friends they should think of it as a second, upgraded bank account. You don’t want to have to use it, but you can if you absolutely need to.

I have a couple friends that think 1 month of cash savings is sufficient. I won’t argue with them. These people are putting gobs of money into investments, and they should have plenty they can withdrawal in case a big expense comes up. They have mastered the most important thing: DISCIPLINE. If all your income goes into your checking account, and you aren’t automating your investing, you will spend that money. If you don’t define a number and say “invest all after I reach $15,000”, you’ll end up with a lot in savings and your money won’t really grow much over time. If you set a saving limit, and invest all the rest, you’ll set yourself up to become rich and financially independent.