While cash is king, paying bonuses with stock shares and equity is a powerful...by Jonathan Anthony
Savings Account or Stocks | Where To Put Your Money
Investing in stocks of some kind and building up a robust liquid saving account is crucial for good financial health. Though they are both necessary elements of a proper portfolio, they are not identical. Knowing the difference between the two is essential, as is knowing when it’s best to choose one over the other.
There are more than a few disparities between savings and stock accounts, one of which is the risk factor. A savings account is essentially risk-free, although it has a much lower return rate than stocks, which offer high returns with increased risk.
Your goals are also important. Stocks tend to cater towards more long-term goals, while a savings account has much more fluidity, ranging from short to long-term goals.
Differences Between a Savings Account and Investing in Stocks
When saving money, you’re obviously not spending it, but more importantly, you’re putting it somewhere accessible for future use. That can be a savings account, a CD (certificate of deposit), or even physically storing it in a shoe box under your bed.
Investing money requires using capital to buy specific assets, such as stocks, bonds, or real estate. The goal is to grow your money and earn profits over time.
Though many people use the words “saving” and “investing” interchangeably, there are some key differences between the two:
- Risk and Return: Perhaps the most significant difference between the two is their risk and return. Savings accounts earn a bit of interest (very tiny), but FDIC-insured accounts carry zero risk. Investments can make you much more over time, but they can also lose you money if the market turns south.
- Time Horizons: Savings accounts are essentially liquid money that you can access anytime in the near future. Investing in the stock market is often a goal that will transcend years or even decades.
- Products: Saved money goes into savings accounts at the bank or sometimes money market accounts and CDs. You can invest money in various products such as stocks, mutual funds, bonds, art, houses, jewelry, and ETFs.
- Hedge Against Inflation: The super-small interest rate on most savings accounts can’t keep up with inflation. So, in a way, you’re slowly losing a bit to the increasing cost of living. Properly structured investments have a much better chance of outpacing inflation and earning you money.
So, Which Should You Put Your Money Into First?
Putting money into a savings account first is a great way to build your portfolio. Build up an emergency fund or “nest egg” to have stability and easy access to funds should an unexpected expense arise. Once your savings account gets established, you can begin investing some of your money.
When to Put Your Money Into a Savings Account
Many experts agree that having savings for unexpected emergencies should be the first reason you set extra money aside. Keep saving until your emergency fund covers at least three months’ expenses. However, some experts advise up to 6 months’ worth.
Not everyone has the extra cash to set aside a massive nest egg. The act of “fast saving” is how many people streamline their budgets. An example of this would be putting money into an account for a specific purpose each month, like paying your mortgage or making a rent payment.
Short-term saving is also typical if you plan on using the money within a set amount of time, typically a few years. Examples include saving for a down payment on a house or saving up to pay for a wedding.
When is it Better to Save Money in a Savings Account?
The best time to use a savings account is when you’ll need short-term access to the money. Whether for a car, patio furniture, or a kid’s college tuition, you’ll want access to all the money you’ve been putting aside when the time comes.
While it could have grown with an investment, there’s always a chance that the market is lower when you go to use the money, and the amount you have access to is smaller than anticipated.
When to Invest Your Money on Stocks
When investing in the stock market, you usually seek long-term growth. Maybe you’re planning to retire, or you want to build up your assets over a longer time horizon and increase your net worth, so you have something to leave your family.
Stocks, bonds, and even real estate can be volatile in the short term but historically pan out in the long run. So, to get the return you want, the investment horizon needs to be inherently further out.
Many people invest in the stock market for retirement through a 401(k) or a Roth IRA. This type of investment can span decades and continually grow as the interest gets reinvested and compounded over the years.
A Few Things to Do Before Investing in Stocks
Investing and saving simultaneously is ideal, although it does not always play out this way. If you are not doing both and are wondering if it’s the right time to invest, ensure you have a few things in order first.
- Make sure that your emergency fund has an adequate amount in it so you can handle any unexpected expenses.
- Pay off high-interest debt. This type of debt can destroy credit and have harmful consequences. Make sure it gets paid down as much as possible before investing. A good rule of thumb is: if the debt’s interest rate is lower than whatever the return rate of the investment is, then the investment would likely be the better option.
- Have an investment goal. This step is often overlooked but is crucial and must be done in advance, alone or with an advisor. Are you saving for retirement? How long is your investment horizon? What is your risk tolerance? All these are questions you need to go over and have an answer for before you begin to invest. Otherwise, you will be building your portfolio without a sense of direction or an end goal.
When is it Better to Invest in Stocks?
Yes, you should try to get your emergency fund filled out first. However, there is one instance where it is wise to invest before you have that in place.
You should always aim to maximize your 401(k) or Roth retirement accounts if your employer matches your contributions to any degree. Many companies match 2, 4, or even 6% on retirement accounts. The match is free money; unless you are genuinely in dire circumstances, you should make this contribution at all costs.
Savings Account Vs. Stocks: Pros and Cons
Below we’ll look at some of the pros and cons of each type of savings to give you a better idea of which is correct for you right now.
Savings Account Pros
- Saving is simple to do. There is no upfront cost or learning curve.
- Bank accounts are very liquid, so you will have no issue getting funds if you need them quickly.
- You will know upfront what interest you will accrue on your savings account.
- The FDIC guarantees any account up to $250,000, ensuring you will not lose any money.
Stock Investing Pros
- Investing in stocks can have significantly higher returns than savings accounts. Over time the S&P 500 stock index has returned 10% annually.
- Bonds, mutual funds, and stocks are pretty liquid and can usually get cashed out when the market is open on most weekdays.
- A diversified and well-structured portfolio of stocks can beat inflation and increase your purchasing power over time.
Savings Account Cons
- Returns on investment will be low.
- Inflation will reduce the power of your dollar.
- Some banks put monthly management fees on savings accounts.
- A federal law called Regulation D states you can only withdraw or transfer funds a maximum of six times per month.
Stock Investing Cons
- Investing can be complex and may require an advisor for guidance, which will cost a fee.
- Your investments can go down in value.
- Stock market investing typically has a longer investment horizon, meaning you may have to keep funds in the account for several years without access to them.
So, Should You Put More Money Into Your Savings or Stocks?
Both investing and saving are going to be critical parts of building a solid financial portfolio, so one is not fundamentally better than the other. However, each one serves a different role throughout your wealth development.
Investing is going to build up in the long run. However, it is of paramount importance to make sure you are ready to invest beforehand, otherwise, you will be setting yourself up for drawbacks. When high-interest debt is snowballing, or you are one emergency away from financial hardship, you’re not ready to start investing.
Building an emergency nest egg in a savings account gives you security and peace of mind. Those things will allow you to start building wealth in other ways.
Other Questions About Savings Accounts or Stocks
Below are some other questions that we hear our users ask about saving and investing for the future.
Are stocks a good way to save money?
That depends. For specific purposes, such as saving for a down payment on a house or a wedding, a savings account will be a much better option. As an investment, stocks tend to do better than cash over the long term, but their volatile nature means you could end up with less when you need it in the short term.
Are there stock savings accounts?
You can use a brokerage or money market account like a stock savings account by buying stocks, bonds, mutual funds, and ETFs and letting the money sit there for a while. Just remember the time horizon needs to be further out to see stable results.
What about the stock market vs. a 401K? Which is better?
Investing of any kind is excellent and gives you a substantial leg up when it comes to building wealth. There are an incredible amount of individual stocks, bonds, and other publicly traded assets on the stock market, each with a slightly different roll of the dice on their projected gains.
If your employer offers a 401(k) plan, especially one that they match, you should invest in that immediately. An employer-matched 401(k) is guaranteed free money in whatever percentage they match. Plus, your 401(k) will be catered towards your retirement and will come with unique benefits upon retirement.
Are CDs better than investing in stocks?
When it comes to investments, everything comes down to risk tolerance. CDs are considered low-risk investments and have a fixed rate that you’ll earn. Stocks have a much broader range of risk profiles and are generally regarded as a higher-risk investment.
One is not better than the other. Your risk tolerance and investing goals will determine which is better suited to your needs.
Are CDs better than using a savings account?
CDs offer a fixed interest rate if you don’t touch your money for a specified time. A savings account will allow more flexibility to withdraw funds whenever needed.
Generally speaking, the best option depends on how frequently you intend to touch the money and how long you are willing to leave it in the account.