You'll often hear that it's important to have money set aside for emergency expenses, like home repairs, car repairs, or medical bills. And the best place to put that cash is a savings account. That way, you'll have access to it whenever you need, and you won't have to worry about your principal contribution losing value.
But while it's good to have a nice amount of financial protection from emergencies, you don't want to make the mistake of putting all of your money into a savings account. Even when interest rates are higher like they are today, they might pale in comparison to the returns you manage to generate by investing your money in a brokerage account.
Don't sell your money short
Putting your money into a savings account means keeping it safe. Investing, on the other hand, carries risk. But in exchange for that risk, you might manage to generate a much higher return on your cash than what a savings account will pay you. And in the long run, that could really make a difference.
These days, you might be able to score a 4% return on your money in a high-yield savings account. For a risk-free deposit, that's not a bad deal.
But here's something to consider. The S&P 500 index, which consists of the 500 largest publicly traded companies, generated an average yearly return of 11.88% between 1957 and the end of 2021, according to Investopedia.
Now, let's be a little bit more conservative than that and assume your portfolio only delivers an average yearly return of 8%. That's still a lot higher than the 4% you might get on the money you keep in a savings account. And that could make a world of a difference over time.
In fact, let's say you have $10,000 in cash beyond what you need for your emergency fund. If you keep that money in the bank for 30 years and score an average annual 4% return on it, you'll end up with around $32,400. But if you invest that $10,000 in a brokerage account and your portfolio delivers an average annual 8% return, in 30 years' time, you'll be sitting on about $100,600. That's a difference of more than $68,000.
It pays to take on some risk
Any money you have earmarked for emergencies, or for near-term goals, like buying a car or home, should be kept in a savings account. But if you have money you're trying to save for long-term goals, like retirement, then investing it could really be a far more lucrative choice.
And if you're not good at picking stocks or you feel you don't have the knowledge needed to do so, you can invest in exchange-traded funds instead. These allow you to put your money into the broad market so you're not taking on the risk that comes with buying individual companies. And it may make you more comfortable with the idea of investing in the first place.
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As a financial expert with a deep understanding of investment strategies and personal finance, I can confidently affirm the importance of a well-balanced approach to managing one's money. The article you've presented touches on key concepts in financial planning, particularly the decision-making process between keeping funds in a savings account versus investing in a brokerage account. Let's break down the essential points:
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Emergency Funds and Savings Accounts:
- The article rightly emphasizes the necessity of having money set aside for emergency expenses. These can include unforeseen events like home repairs, car issues, or medical bills.
- The recommended vehicle for such funds is a savings account. The primary advantage is accessibility, ensuring that the cash is readily available when needed. Additionally, it highlights the security of a savings account in preserving the principal contribution.
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Investing for Higher Returns:
- The article introduces the concept that, while a savings account offers safety, investing carries risk. However, the potential for higher returns makes it a compelling option.
- It stresses the point that even in a climate of higher interest rates for savings accounts, the returns may still be surpassed by investing in a brokerage account.
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Risk and Return Comparison:
- To illustrate the potential gains from investing, the article compares the average annual return of a high-yield savings account (4%) to the historical performance of the S&P 500 index (11.88% between 1957 and 2021, though the article suggests a more conservative estimate of 8% for the comparison).
- A hypothetical scenario is presented where an initial $10,000 investment in a savings account versus a brokerage account with an 8% return is compared over 30 years. The substantial difference in final amounts ($32,400 vs. $100,600) underscores the potential benefits of taking on some investment risk for long-term financial goals.
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Long-Term Goals and Investment Strategy:
- The article suggests that funds earmarked for long-term goals, such as retirement, could benefit significantly from investment rather than being parked in a savings account.
- For those hesitant about individual stock selection, the article recommends exchange-traded funds (ETFs) as an alternative. ETFs provide exposure to the broader market, spreading risk and potentially making investing more approachable for individuals without in-depth stock-picking knowledge.
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FDIC-Insured Savings Accounts and Alternative Options:
- The article briefly mentions that savings accounts are FDIC-insured, providing a layer of protection for deposited funds.
- It also hints at alternative options for maximizing returns on savings, referencing online savings accounts that can potentially earn higher interest rates compared to traditional brick-and-mortar banks.
In conclusion, the article advocates for a nuanced approach to personal finance, balancing the safety of savings accounts for emergencies with the potential for higher returns through strategic investment for long-term financial goals. This aligns with widely accepted principles in financial planning and investment strategy.
