Last Updated on December 2, 2024
Overview
There are many variables that contribute to an individual’s financial health; one of the most popular (and arguably the easiest to implement) is putting money aside for savings.
Many people, both young and old, understand the importance of putting aside enough money in case life throws a curveball at them. When an unexpected financial event happens, one’s savings should be able to cover, or at least cover a reasonable amount, of the expense, with the hope of not needing to use debt.
Saving precedes investing. A person cannot become an investor if they have no capital to deploy.
While many people understand the importance of saving, what separates an investor from a non-investor is how they view money, and what they do with a large amount of cash.
Unproductive Money
Investing is essentially the act of putting money to work: that is, using money to make more money.
A non-investor may simply view their savings as a fund they can access when the need arises. Until such a time arrives, accumulated funds will be tucked away, waiting patiently to be deployed.
While putting funds aside is important, the problem with this approach is that the money is not being used productively. That is, the money is simply being viewed as something to be spent, not as a tool that can be deployed to create wealth.
Interest-bearing savings accounts are one solution to this problem of unproductive money. Interest payments are intermittently deposited into a savings account, usually monthly. Every month a savings account balance becomes that much larger.
Although this is a good start, the saved funds are not being used to its fullest potential. Most interest-bearing savings accounts offer abysmal interest rates.
My savings account is classified as “high interest”, but the interest rate is only 0.05%. To put that into perspective, every $1000 would only yield 50 cents. No wonder the amount of money I have in savings is considerably smaller than the money I have invested. Although interest is compounded monthly, keeping money in a savings account won’t make you wealthy anytime soon.
Large amounts of money simply being kept aside and not doing anything represents a major opportunity cost.
Putting Your Money to Work
While most investors also understand the importance of saving, they don’t view saved funds as just money waiting to be spent.
Instead, each unit of money represents one worker, or in other words something waiting to be deployed for productive use. A savings account, or any large sum of money, therefore represents an untapped workforce waiting to be utilized.
Viewing money as something that can be put to work instead of something just to be spent is the mindset that separates investors from non-investors.
One of my favourite personal finance books, The Richest Man in Babylon by George S. Clason, discusses the importance of “make thy gold multiply” (i.e. put your money to work) as one of the tenets of living a financially successful life.
Money is the ideal worker: it doesn’t need breaks, it won’t go on vacation, it’ll do any job, and it will work for you 24/7/365. And the best part of all, it does all of that for free.
Despite this, many people fail to make the most of this formidable workforce. No business would simply allow their employees to stand around idly, so it baffles me that people do this with their money.
As of May 2020, Berkshire Hathaway, Warren Buffett’s conglomerate, had a record $137 billion in cash.
Lots of market commentators and other investors were giving Mr. Buffett lots of flack because he has yet to deploy all that capital. With that much money on the table, not putting it to work would be unthinkable.
Nothing agitates investors more than having a lot of cash sitting around not doing anything. An investor understands that having lots of cash on hand represents a wasted opportunity because that cash could be deployed to make itself multiply. Unless that money is being put to work, it won’t benefit you much by having it sit around.
Of course, one argument for having ample savings is the need for liquidity (i.e. having cash or cash equivalents on hand). Tying up too much money into illiquid assets (assets that are difficult to sell for cash) could lead to a cash crunch.
Having some liquidity on hand is important, yes, but a fine balance must be struck between adequate liquidity and wasting an opportunity to make productive use of your money.
Maintaining Liquidity
Building on that last point, while saving to invest is a major step up from saving just to save, it’s important to remember not to tie up all your money (or a significant amount of your money) in investments.
It is possible for someone to be asset rich, but cash poor. Put another way, a person may have a very formidable investment portfolio comprised of several asset classes but may only have a modicum of cash.
You can’t buy groceries or pay the bills by offering your shares or apartment building as payment. Individuals must understand their liquidity needs and plan their investment strategy accordingly. This is why it’s important to maintain adequate liquidity – what classifies as “adequate” varies for everyone.
A common way to maintain liquidity while still putting your money to work is to hold short-term assets such as a certificate of deposit (CD) at a bank (or a Guaranteed Investment Certificate [GIC] when it comes to Canadian banks). They are like bonds in that they pay interest payments and return your principal upon expiring.
The catch is CDs have a set holding period, such as one year. Short-term assets are an excellent option for people who need cash in future but don’t see themselves spending it tomorrow. Like any investment, it would be unwise to tie up too much money into short-term assets.
Again, saving to invest is important, but saving for a rainy day still plays a role in maintaining healthy finances. Individuals need to understand their liquidity needs to ensure they don’t find themselves in need of cash but are unable to acquire it in time.
Wrapping Up
Saving is a tenet to maintaining excellent financial health, and it precedes investing, but having lots of funds in reserve without putting it to work is a wasted opportunity to generate wealth.
Instead of viewing money as something to spend, individuals who want to start investing must learn to instead view money as the ultimate workforce waiting to be utilized. Money is the perfect worker, not utilizing such a powerful resource is absurd.
While saving to invest is important, individuals must understand their personal financial situations and ascertain how much liquidity they need. Not having enough cash on hand is a real problem some people find themselves in, but adequate planning beforehand can prevent this. A balance needs to be struck between adequate liquidity and making productive use of your money.
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