Investing is different from saving. Saving is a passive activity, even though it uses the same principle of compounding. Saving is more focused on safety of principal (the amount you start out with) and less concerned with return.
Your focus in investing is on return and can run the spectrum from conservative to very aggressive in terms of risk. One way you measure results is by the expected return weighed against the anticipated risks.
It is easy to slip into an unnecessarily complex discussion about whether a particular financial transaction was an investment or a savings deposit. However, it is important to understand that investing has some distinctive characteristics, which separate it from pure savings. Since we are discussing stocks, Ill limit the characteristics to that type of investment:
- Upside Potential
OwnershipWhen you buy stock, you are buying a piece of a company you become a part owner. This ownership gives you certain rights, including voting on important matters before the company and participating in the profits if the company distributes dividends.
Virtually no savings instruments give you ownership. You may own a bank CD, but you dont own part of the bank. You may own a U.S. Treasury bond, but you dont own the government.
Upside PotentialWhen you own stock, you participate in the growth of the company. As the value of the company increases, so does you investment. If profits increase, you may receive bigger dividend checks. The stock price may continue to rise for a long period. Many of the early employees of Microsoft are millionaires because their stock has gone up dramatically.
If you have a bank CD that pays 3%, it is unlikely the banks president is going to call you one day and say, weve had a great year, so Im raising your interest rate to 6%.
RiskAlong with the potential for extraordinary gain is the potential for loss. These two go hand in hand. You can lose money investing in stocks.
If the thought of losing money makes your stomach knot up, stick to savings instruments. However, you should know that even the safest savings instrument carries unseen risks. Most savings instruments trade security for return, meaning they pay very little. When you factor in inflation and taxes, many so-called safe savings instruments return almost nothing and some can actually lose ground.
For a more detailed discussion of risk, see my cleverly titled article: Understanding Risk .