There are basically two ways to make money. 1. You work for money. Someone pays you to work for them or you have your own business. 2. Your money works for you. You take your money and you save or invest it.
Your money can work for you in two ways:
Your money earns money. When your money goes to work, it may earn a steady paycheck. Someone pays you to use your money for a period of time. When you get your money back, you get it back plus "interest". Or, if you buy stock in a company that pays "dividends" to shareholders, the company may pay you a portion of its earnings on a regular basis. Your money can make an "income", just like you. You can make more money when you and your money work.
You buy something with your money that could increase in value. You become an owner of something that you hope increases in value over time. When you need your money back, you sell it, hoping someone else will pay you more for it. For instance, you buy a piece of land thinking it will increase in value as more businesses or people move into your town. You expect to sell the land in five, ten, or twenty years when someone will buy it from you for a lot more money than you paid.
And sometimes, your money can do both at the same time earn a steady paycheck and increase in value.
The Differences Between Saving and Investing
Saving
Your "savings" are usually put into the safest places, or
products, that allow you access to your money at any
time. Savings products include savings accounts, checking
accounts, and certificates of deposit. At some banks and
savings&loan associations your deposits may be insured
by the Federal Deposit Insurance Corporation (FDIC). But
there's a tradeoff for security and ready availability. Your
money is paid a low wage as it works for you.
After paying off credit cards or other high interest debt, most smart investors put enough money in a savings product to cover an emergency, like sudden unemployment. Some make sure they have up to six months of their income in savings so that they know it will absolutely be there for them when they need it.
But how "safe" is a savings account if you leave all of your money there for a long time, and the interest it earns doesn't keep up with inflation? What if you save a dollar when it can buy a loaf of bread. But years later when you withdraw that dollar plus the interest you earned on it, it can only buy half a loaf? This is why many people put some of their money in savings, but look to investing so they can earn more over long periods of time, say three years or longer.
Investing
When you "invest", you have a greater chance of losing
your money than when you "save." Unlike FDIC-insured
deposits, the money you invest in securities, mutual
funds, and other similar
investments is not federally
insured. You could lose your
"principal" the amount
you've invested. But you
also have the opportunity to
earn more money.
All investments involve taking on risk. It's important that you go into any investment in stocks, bonds or mutual funds with a full understanding that you could lose some or all of your money in any one investment. While over the long term the stock market has historically provided around 10% annual returns (closer to 6% or 7% "real" returns when you subtract for the effects of inflation), the long term does sometimes take a rather long, long time to play out. Those who invested all of their money in the stock market at its peak in 1929 (before the stock market crash) would wait over 20 years to see the stock market return to the same level.