“You have to save money!”

It’s a very general statement. We hear it all the time, but it turns out it can mean different things to different people.

For example, “saving money” could legitimately refer to getting a better deal on something that you were going to buy. Maybe you’ve been eyeing a particular new winter coat, but you scour the web looking for deeply discounted sale and are able to “save 20%”. Or perhaps instead of buying that coat, you decide to save money by looking at a different coat that just costs less and maybe end up saving 30% versus what you were originally planning on spending.

But when it comes to getting a handle on your money, more often than not, the phrase “you have to save your money”, refers to putting money away for the future. What that future holds is partly up to you, and partly up to chance. Let’s take a look the main reasons people save money for the future.

An Emergency Fund

This falls under the “partly up to chance” category. Emergency expenses are unplanned, but happen from time to time. If you lose your job, you lose your income. An emergency fund can help keep you afloat while you figure out where your next paycheck will be coming from. Or perhaps you need to make an emergency trip if a friend or family member becomes gravely ill, or dies unexpectedly. It’s important to note that things like car maintenance costs don’t really fall into the emergency fund category, because maintenance on a car is a given. That should be part of your budgeting for owning a vehicle.

Pre-Planned Spending

You can think of this as short-term savings. If you know you are going to head south for spring break, then you can start saving up for it in advance, as opposed to putting all your expenses on a credit card and chipping away at it after the fact. Pre-planned spending is also where your car maintenance costs should come from, because again, we know that you’ll need oil changes, tire rotations, brake pad replacements, and more, over time.

Long-Term Savings

When you’re young, the “long” in long-term savings might refer to a spending goal that is perhaps five to ten years away, like saving up for a down-payment on a home. Especially with house prices being so high, a proper down payment can feel like it will take an eternity to save up for. But most of the time, “long-term savings” is used interchangeably with “saving for retirement”. Young adults today may want to plan to retire no earlier than in their 70s since the average health and activity levels will be higher than for previous generations. You might also live longer, meaning you’ll need to have more saved up (or be retired for a shorter period of time). And heck, retirement may look totally different compared to today. Maybe most people will simply slow down and work part-time until they kick it. Regardless, “saving” for retirement doesn’t mean putting money away into a savings account. It means saving money regularly and taking those savings and investing them so that they will hopefully grow faster than in a savings account. Using a simple example, imagine someone saved $100 per month for 50 years into either a savings account earning 1% per year or an investment portfolio earning 5% per year. With the savings account, you would end up with almost $78,000. But with the investment portfolio, you could potentially end up with almost $267,000. That’s the power of compound interest over long time periods.

The trade-off with an investment portfolio with a potentially higher return is that the value of those investments will fluctuate both up and down over time, and that is much harder to live with than the reliable, but lower returns of a savings account.