Req 4 — Saving vs. Investing

4a: Saving vs. Investing

Saving means putting money aside in a safe, easily accessible place — like a savings account or a piggy bank. Your money is protected, you can get to it whenever you need it, and it earns a small amount of interest. The trade-off is that it grows slowly.

Investing means putting money into something — like stocks, bonds, or real estate — with the expectation that it will grow in value over time. Investing offers the potential for much higher returns than saving, but it comes with risk. Your investment could lose value, and your money is usually not as easy to access quickly.

When to save:

• For short-term goals (less than 3–5 years away)
• For your emergency fund
• When you cannot afford to lose the money

When to invest:

• For long-term goals (5+ years away, like college or retirement)
• When you have already built an emergency fund
• When you can handle some ups and downs in value

4b: Return on Investment and Risk

Return on investment (ROI) measures how much money you earn (or lose) compared to how much you put in. If you invest $100 and it grows to $110, your return is $10, or 10%.

Risk is the chance that your investment could lose value. A savings account at an FDIC-insured bank has almost zero risk — your money is guaranteed. A stock in a single company has much higher risk — the company could do great, or it could go bankrupt.

Here is the key relationship: higher potential returns come with higher risk. This is one of the most fundamental rules of finance. No investment offers high returns with no risk — if someone promises that, it is a scam.

4c: Simple Interest vs. Compound Interest

Simple interest is calculated only on the original amount you deposited (called the principal). If you deposit $1,000 at 5% simple interest, you earn $50 every year — always $50, because it is always 5% of the original $1,000.

Compound interest is calculated on the principal plus any interest you have already earned. This is where the magic happens:

• Year 1: $1,000 × 5% = $50 in interest → Balance: $1,050
• Year 2: $1,050 × 5% = $52.50 in interest → Balance: $1,102.50
• Year 3: $1,102.50 × 5% = $55.13 in interest → Balance: $1,157.63

See how the interest grows each year? You are earning interest on your interest. Over long periods, this snowball effect becomes enormous.

After 10 years at 5%:

• Simple interest: $1,000 + $500 = $1,500
• Compound interest: $1,628.89

After 30 years at 5%:

• Simple interest: $1,000 + $1,500 = $2,500
• Compound interest: $4,321.94

4d: Diversification

Diversification means spreading your investments across different types of assets so that if one performs poorly, others may perform well and balance it out. It is the financial version of “don’t put all your eggs in one basket.”

Imagine you invest all your money in one company. If that company has a bad year, you lose a lot. But if you invest in 50 different companies across different industries, one bad performer barely dents your overall portfolio.

You can diversify across:

• Asset types: Stocks, bonds, real estate, savings accounts
• Industries: Technology, healthcare, energy, consumer goods
• Geography: U.S. companies, international companies
• Company size: Large established companies and small growing ones

Mutual funds, which you will learn about in Requirement 5, are one of the easiest ways to diversify because a single fund holds many different investments.

4e: Why Save and Invest for Retirement

Retirement might seem impossibly far away when you are a teenager, but that distance is actually your biggest advantage. Starting early gives compound interest decades to work.

Consider two people:

• Scout A starts investing $100 per month at age 18 and stops at age 28 (10 years, $12,000 total invested)
• Scout B starts investing $100 per month at age 28 and continues until age 65 (37 years, $44,400 total invested)

At a 7% average annual return, Scout A ends up with more money at age 65 than Scout B — even though Scout A invested for only 10 years and Scout B invested for 37 years. That is the power of starting early.