Savings Account vs. Investing

I think many people at some point contempt whether they might be better off putting their money into a savings account versus investing that money. First, for our purposes we will assume that we would be using an FDIC insured high yield account savings account. A Google search result of those types of accounts can be found here. The reason why we are assuming this is because those are the savings accounts would likely give other investment options the best challenge. Additionally, if you are currently earning less then 3% a year at your local bank, you should likely consider other options available in the marketplace.

Recently, we have experienced a lot of market volatility. I had one of my close personal friends, who is not in the financial industry, comment that it’s been a terrible year, as his index based investments are off about 5 percent from when he bought in. This is distressing for a lot of people as no one is happy with losing money. Given this psychological disposition it sometimes seems like a prudent decision to place your long-term money into a savings account.

For the long-term investor who has designated this money for retirement is almost never a good decision to place this money into a savings account. It is true that the money will likely experience less volatility, but over a long time frame it will seriously impact the amount of principal you have. A quick and dirty example is let us assume a person has $10,000 to invest with a 30 year time frame. Further, let us assume that the person can likely earn an 8.5% return by investing in a basket of index funds and earn 5.1% in a high yield savings account. At the end of those 30 years the person who invested in the basket of index funds will have $115,583 in the bank; while the person who put the money in a savings account would only have $44,471 available. That is a substantial difference.

For the short-term investor or an investor who is looking for income and not concerned with the growth of principal the savings account is a viable choice. There are a number of savings accounts which yield more then some bonds and bond funds. However, it is important to note that these accounts often times move with the interest rate market and if the Federal Reserve decided to cut interest rates (which seems like a possibility in the future) this could reduce the interest on the account and likewise reduce the amount of income a person would receive from the account. The savings account also makes sense for someone who will need money in the very near future and cannot risk take a loss right before the money is needed.

An individual should review their circumstances and financial goals. In some cases putting money into a savings account is a bad choice while in others it can be the perfect fit. As always, please consult with an investment and tax professional before making any financial decisions.

The “best” investment strategy

Many people ask “What is the best investment strategy for someone in my position?” This question is universal whether it is a single woman over 50 or a couple in their early twenties with children. The short answer is there is no single best investment strategy for any broad range of people. An individual or family’s situation and needs are what goes into determining what kind of investment strategy to pursue.

Let’s take a closer look at the example of the couple in their 20’s with children. On the face of it some advisers might suggest that this couple could be very aggressive with their investment portfolio, as they have a very long investment horizon and many years to ride out any unforeseen market declines. However, if one of the couple’s goals is to buy a home with a backyard so their children can play safely outside, this changes the long-term horizon dramatically. Assuming their child was just born they would have between 2 and at most 3 years until this need (and money) will be realized. This is a very short time horizon in the world of investing. Given this situation, one possible investment strategy would be to invest all of their savings into short-term US government securities. These financial instruments are backed by the full faith and credit of the United States government. Also with their short time frame to maturity the couple’s money should experience less volatility then a portfolio comprised of both stocks and bonds. This solution gives the couple a way to make their money work for them until they buy their first house, while at the same time being able to sleep easy at night.

Next, let’s look at the single woman who is in her 50’s. Let's assume that this person has an executive level position and good health. In addition to having a well paying job she also has a sizable amount of equity in her home, sufficient emergency cash reserves, does not expect to retire from working until the age of 67 and considers herself an aggressive investor who is comfortable with the volatility that the market sometimes produces. Here, the exact opposite is true from our young couple. This woman could allocate her portfolio 100 percent into a diversified set of companies, both US and foreign. The reason being is that she has a much longer time horizon then the young couple for this money. Additionally, if any unexpected expenses arose she could pay for those out of her substantial emergency cash fund and not have to worry about selling any of her portfolio companies at an inopportune time.

So, when you go to consider an allocation for your portfolio or when you go and talk to an adviser be aware there is no magic formula for how much should be placed in bonds, stocks, mutual funds, or other investments. It all depends on YOUR financial situation and goals; both long and short term.

Finding Money to Invest

One of the most common questions that I get asked is where to start. Often times individuals, especially younger people, have little to no excess income after paying all their bills and entertainment expenses. If they do have money left over it is usually an amount which they perceive to not be worth investing. However, nothing could be further from the truth.

Investing is not something that happens in a few days, weeks, months, or years. It is a lifetime pursuit. Given this, over time a little bit of savings here and there has the potential to add up into amount that can be used to fulfill a person’s goals.

Step 1: Start small. Most people in the stock market did not start off with a million dollars. If you have a spare $200 dollars in your savings account that is a great place to start! You should find a broker or firm who is willing to speak with you about your investments and objectives and take the time to work with you. It is unlikely you will have your own advisor at a major brokerage firm with $200 but there are more then enough advisers out there who would be eager to speak with you about investments that might make sense for your situation.

Step 2: Once you have decided on the investment that suits you best stick with it. Day trading, swing trading and other similar types of investing methodologies make one group of people rich; brokers.

Step 3: Add to your investments in small but frequent amounts if possible. Most everyone can skip one meal out or skip one night out at the bar or movies. Use the money you saved to add to your investments. For example, if a person was able to save an extra $50 dollars a month by skipping these activities that would add up to over $600 per year that could be used for additional investments.

Step 4: Relax and enjoy the power of compounding returns. If a person started an investment with $200 dollars and each year added $600 dollars by the end of 30 years assuming an average return of 8% per year that investment would be worth over $76,000! It is also interesting to note that the amount of money deposited into the investment was only $18,200 during the 30 year period.

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