How Much Money to Have in Savings vs Investments

Striking the right balance between savings and investments can be a challenging task. You may wonder where to allocate more funds and whether you should prioritize savings or focus on investments. While both are essential components of a financial plan, investments generally offer more benefits and should occupy a larger share of your financial strategy. Having said that, it is important to understand the importance of both.

A financial advisor can help you understand how much money you should have in savings vs investing. This article will also break this down in detail.

What are investments and how do they help?

Investments help you build wealth over time with the magic of compounding. When you invest, your money is put into assets like stocks, bonds, mutual funds, gold, cryptocurrencies, commodities, or real estate, which can grow in value depending on market conditions. Investments are designed for growth and can help you achieve seemingly significant financial goals, such as buying a home or retiring comfortably. Here’s where investing your money can help:

1. You have long-term goals

Investing is particularly powerful when it comes to achieving long-term financial goals like retirement, buying a home, or funding a child’s education. These goals often require substantial amounts of money that are difficult, if not impossible, to accumulate through savings alone. Investing allows your money to grow over time, which makes these goals achievable.

For example, if your annual income is $80,000, you might need a retirement nest egg of approximately $2 million to maintain your lifestyle after retiring. Saving $2 million by stashing money in a savings account would be incredibly challenging due to low interest rates. However, investing in retirement accounts, stocks, mutual funds, etc., which typically yield higher returns, can make this target attainable. Over decades, your contributions can grow exponentially, helping you retire comfortably without financial stress.

Homeownership is also becoming increasingly expensive. According to the National Association of Realtors (NAR), the median home price in the U.S. hit an all-time high of $419,300 in 2023. Saving such a large sum can be daunting. However, you can build a substantial down payment over time through investments. Education costs are also rising steadily. For instance, the average cost of attending a four-year public college is about $10,560 annually. Over four years, this totals more than $42,000, and that is just for tuition. Investing in a 529 plan or other tax-advantaged education savings accounts can help your money grow while you take advantage of tax benefits.

2. You have future healthcare expenses to think about

Healthcare expenses may be the most impacted by inflation. So, the earlier you start investing in healthcare, the better prepared you will be. If you are diagnosed with a condition requiring ongoing care, these costs can become overwhelming. Even if you are in good health today, planning for future healthcare needs is essential. If unprepared, these costs could deplete your savings. For instance, you can use a Health Savings Account (HSA). HSAs not only offer returns but also provide tax-deferred growth and tax-free withdrawals for qualified expenses.

3. You have access to employer-sponsored plans

If your employer offers a retirement savings plan like a 401(k), you can use it to prepare for long-term goals like retirement while enjoying tax advantages and, in many cases, employer matches that enhance your savings. For traditional 401(k)s, your contributions are made pre-tax, which reduces your taxable income now, though withdrawals in retirement will be taxed. By contrast, Roth 401(k)s involve after-tax contributions, but qualified withdrawals during retirement are tax-free. Both options allow you to build wealth efficiently, with the added benefit of compounded growth. Moreover, many companies match a percentage of your contributions. Over time, these matches can make a significant difference in your retirement fund.

If you are looking to make the most of your 401(k) in 2025, it is essential to understand the updated contribution limits. The maximum limit for employees is $23,500 for 2025. The cap is set at $70,000 for combined contributions from you and your employer. For those aged 50 or older, additional catch-up contributions are available to help boost retirement savings. Individuals aged 50 and above can contribute an extra $7,500, bringing their total possible contribution to $31,000 in 2025. The SECURE Act 2.0 also introduced a higher catch-up limit for individuals aged 60 to 63. Beginning in 2025, this group can contribute up to $11,250 as a catch-up, raising their total contribution potential to $34,750 annually.

4. You have extra money you do not need anytime soon

Investing can be the smartest choice if you find yourself with extra money you do not need for essentials or immediate expenses. Letting surplus funds sit idle in a savings account or spending them impulsively can limit your financial growth. Instead, you can invest them to earn profits and build wealth. Investments such as stocks, mutual funds, bonds, real estate, and others have the potential to generate higher returns over the long term. Channeling your extra money into these assets can allow you to earn returns on your funds.

Moreover, investing surplus money prevents wasteful spending. It is easy to splurge when you have extra cash lying around. Instead, investing allows you to focus on achieving your financial goals and be financially secure not just now but also in the future. You can use year-end bonuses or pay raises to increase your investments. Additionally, if you have money left over after covering your monthly expenses, you can set up an automatic transfer to an investment account to ensure the money does not just sit idle. Inheritances can also be invested. If you inherit money, consider investing it to ensure financial security for years to come.

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What are savings and how do they help?

Savings help you prepare for a rainy day and maintain financial liquidity. They provide immediate financial security in case of an emergency. While they offer little to no growth, savings can give you peace of mind when unexpected expenses arise. Here are some things that savings can help you with:

1. Upcoming bills and expenses

Savings can help you cover upcoming bills and expenses. These might range from essentials like electricity, water, and rent to lifestyle-related costs such as OTT subscriptions, club memberships, and Wi-Fi services. Some of these bills recur monthly, while others may be paid quarterly, semi-annually, or annually. Additionally, you might have credit card dues or other payments that need timely attention.

Having savings readily accessible can help you manage these recurring expenses with ease. Experts recommend keeping about one to two months’ worth of expenses in your checking account. This ensures you always have enough funds to cover your bills without any stress. With sufficient savings on hand, you will not have to worry about missing payments or falling behind on obligations.

2. Emergency expenses

Emergency savings keep you prepared for life’s unpredictable challenges, such as unexpected medical procedures, a sudden car breakdown, job loss, business failure, or a surprise home repair. Having a dedicated emergency fund ensures you do not have to rely on credit cards or loans to cover these costs. It also provides peace of mind. Your emergency fund should cover essential costs like rent or mortgage payments, utilities, groceries, insurance premiums, and minimum debt payments. So, you can maintain your standard of living comfortably.

You can use a high-yield savings account to keep your emergency funds. This account offers two key benefits. Firstly, your money remains secure compared to if you were to store it at home. Secondly, it earns interest over time, which offers some growth. Moreover, storing your money in a high-yield savings account also provides quick access.

The general recommendation is to save three to six months’ worth of living expenses. However, the ideal amount for an emergency fund depends on your personal circumstances, lifestyle, and income. For example, if you have a steady income and job security, three months’ worth of expenses might be sufficient. However, if your job is less stable or your income fluctuates, which is common for freelancers, contractors, and even entrepreneurs, it is wise to aim for at least six months. Additionally, it is beneficial to keep an extra buffer of perhaps two months’ worth of expenses beyond your primary emergency fund. This extra money can be used during extended periods of financial uncertainty or when dealing with particularly costly emergencies.

3. Nearing financial goals

When you are getting close to reaching a financial goal, such as saving for a down payment on a house or a major purchase within the next one to three years, it is essential to prioritize safety and accessibility for your funds. In this case, your money can be in a savings account or other low-risk, short-term investments that provide a safe, liquid option for your funds. Using a high-yield savings account is an excellent way to store money for goals that are just around the corner. These accounts offer higher interest rates, allowing your funds to grow while still being easily accessible. Since you will likely need the funds soon, a high-yield savings account ensures that your money is not exposed to market risks and remains secure.

It is important to note that as you approach the time when you will need the money, you should begin liquidating any investments that you have been holding for that goal. For example, if you have been investing in the stock market or other higher-risk assets, you should start converting those investments into cash or a high-yield savings account a few years before the goal date.

How much money to have in savings vs investments?

Determining the right balance between savings and investments depends on various factors, including your personal goals, financial situation, age, and income. If you have imminent financial goals, such as buying a house, going on a vacation, or paying off debt, you might need more money in savings. These short-term goals require liquidity and stability. Savings provide you with the flexibility to access your money easily without worrying about market fluctuations. On the other hand, if you are preparing for long-term goals like retirement, investments are more appropriate. Investments, such as stocks, bonds, mutual funds, and real estate, tend to grow over time and outpace inflation.

The right mix of savings and investments also depends on your income and age. You might be able to invest more if you have a steady income. Alternatively, if your income is unpredictable, having a larger portion in savings might be necessary to cover your expenses. Younger individuals can generally afford to take more risks by investing more. As you get older and approach retirement, it is recommended to move to safer options.

Having said that, while both savings and investments are important, investments are generally more beneficial in the long term because they offer the potential for growth, helping your money grow at a rate that outpaces inflation. On the other hand, savings offer stability and safety but typically do not provide the same opportunity for growth, which could leave your money stagnant over time. Working with a financial advisor can help you figure out the best strategy for your unique circumstances.

To conclude

Now that you have a better understanding of the differences between savings and investments and how each plays a role in your financial journey, you can craft a strategy that works for you. Remember, both are important components of a well-rounded financial plan. However, investing tends to offer more potential for building wealth over time. It allows your money to grow and outpace inflation and helps you achieve long-term goals like retirement or buying a home. A financial advisor can help you assess your situation, identify your goals, and create the ideal balance that aligns with your financial aspirations.

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