What is the difference between saving and investing? To put it bluntly, saving is setting aside money, while investing it putting it to work to make more money.
But let’s back up a step. Certainly, you know the fable of the Ants and the Grasshopper. As the summer sun shines, the ants work hard piling up grain. The grasshopper laughs and fiddles away his time, enjoying the plenty.
Winter comes and, predictably, the ants have food to eat and grasshopper is reduced to begging from the industrious ants.
A simple story, and there’s a lot of truth to the tale. The ants, of course, are savers. Bully for them. But that doesn’t mean they are investing. They’re just storing up grains for winter. Come closer, Grasshopper.
If all you had to do to retire is pile up cash, then Wall Street could evaporate tomorrow. We wouldn’t even need banks, just lock boxes in our homes full of paper money. A cup of coffee today that costs $1 today will cost $1 in the future, right?
Er, of course not. Inflation will see to that. Your $1 coffee cost 11 cents in 1950 and 9 cents in 1920, and so on. Something that cost a buck in 1920 runs you north of $12 today. It’s not hard to see inflation coming, really. Even moderate inflation is devastating over a lifetime, and you should probably count on a long retirement.
So, to return to our story, the grains the ants have put away have this curious problem of rotting away. They need help besides simply piling it up. Enter investing.
Most people understand that somebody has to take on the risk of expanding a business. Not to create jobs or better others’ lives with products and services (a nice side effect, really) but to make more money.
You, the Capitalist
Investment is the wellspring of capitalism: The economy is not a zero-sum game, where I win by causing you to lose. Companies need capital to grow, which they raise either by borrowing (bonds) or by issuing stock. If they allocate it correctly, everyone wins — shareholders, consumers, employees, tax collectors, and future investors, too.
As an investor, you get a slice of that success, which comes back to you in the form of interest payments, dividends, price appreciation or a combination of all three.
How much you invest and on what terms are the sticking points. Wall Street is a conduit, one among many. Or you could buy into mutual funds or, better yet, inexpensive index funds or exchange-traded funds that track entire markets.
Banks, of course, are another way, through savings accounts and CDs, or you could buy U.S. Treasury debt directly, bypassing the institutions.
While the ways to invest vary greatly, they all fall along a simple continuum of risk and reward. Your job as an investor is to seek the highest after-inflation return at the lowest possible risk. When serious financial advisors talk about a market return, what they typically mean “compounded, risk-adjusted return,” enough money to keep you from becoming the poor, starving grasshopper.
Grains, Piled High
In short, your grains are not only piling up but are multiplying faster than they rot away, with no extra effort from you other than carefully overseeing the process. If you do it right, you someday get to play grasshopper whatever the season.
The starting point of all of this activity, naturally, is saving first. Only by having money set aside for investing — above and beyond your rainy-day fund — can you comfortably think beyond the winter and into the years ahead, when a serious investment plan will turn out to have been a wise course indeed.