Should You Focus on Saving or Investing?

Why saving is for the poor and investing is for the rich

Before you shoot me down for saying that investing is for the rich, hear me out. I don’t mean you should only save and not invest. Rather, it is important to know where your focus should lie. If you have little capital and are focusing on generating returns rather than saving, you’re doing it wrong.

If you don’t have much money invested, then you should focus on increasing your savings (and investing it). However, if you already have a sizeable portfolio, then you should spend more time thinking about details of your investment plan.

Let’s say you are able to achieve a 20% annual return on capital. A 20% return on $1,000 is $200. That’s hardly enough to retire on. A 20% return on $10,000 is $2,000. While that’s still far from enough to cover your annual expenses, it does feel like a step in the right direction. A 20% return on $100,000 works out to be $20,000 and now we’re talking. This is where the law of large numbers comes into play.

The Save-Invest Continuum

In his book “Just Keep Buying”, Nick Maggiulli talks about the Save-Invest continuum. Where you lie on this continuum will determine whether your focus should be on saving or investing.

Where Are You on the Save-Invest Continuum?

First, figure out your expected savings (i.e. how much you expect to comfortably save in the next year.) This should be something that you can achieve with ease. Next, determine your expected investment growth (i.e.how much you expect your investments to grow in the next year) in dollar terms. Finally, compare the two numbers. Which is higher?

If your expected savings are higher, then you need to focus more on saving money and adding to your investments. If your expected investment growth is higher, then spend more time thinking about how to invest what you already have. If the numbers are close, spend time on both.

In the first few decades of working, most of the annual change in wealth is being generated by yearly savings. In the final few decades, it is investments that contribute far more to yearly growth. The shift is so pronounced that, by the end of one’s working life, nearly 70% of total wealth comes from investment gains, rather than annual contributions.

Conclusion

I used to think that the way to go was to aim for the highest returns. The problem is that when you have a small capital, getting high returns will not make much of a difference to your overall wealth. The priority at the start would be to save and invest as much as possible. Do this until your expected investment growth exceeds your expected savings, in dollar terms. Only then should you be thinking of your returns.