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 seasoned financial expert with years of experience in wealth management and investment strategy, I've navigated the intricate landscape of personal finance, consistently demonstrating a profound understanding of the dynamics between risk and reward. My expertise extends to various investment vehicles, including stocks, bonds, and alternative assets, enabling me to provide comprehensive advice tailored to individual financial goals.
Now, let's delve into the concepts discussed in the article:
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Emergency Fund Importance: The article emphasizes the importance of having an emergency fund to cover unforeseen expenses such as home repairs, car repairs, or medical bills. This is a fundamental concept in personal finance. An emergency fund acts as a financial safety net, preventing individuals from resorting to high-interest debt in times of crisis.
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Savings Account as a Safe Haven: The article suggests that a savings account is the best place to store money for emergency expenses. The key advantage is liquidity – the ability to access funds quickly and without risk. The article rightly acknowledges that a savings account ensures the principal contribution remains stable, providing a secure foundation for short-term financial needs.
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Limitations of a Savings Account: While promoting the merits of a savings account, the article warns against the mistake of putting all money into it. This is a crucial point, as savings accounts typically offer lower interest rates compared to other investment options. It introduces the idea that solely relying on a savings account may lead to missed opportunities for higher returns.
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Investing for Higher Returns: The article contrasts the safety of a savings account with the potential for higher returns through investing in a brokerage account. It explains that investing involves risk, but the potential reward, especially over the long term, can significantly outpace the returns from a savings account.
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Historical Investment Returns: The article cites historical data, specifically mentioning the average yearly return of the S&P 500 index between 1957 and the end of 2021. This data supports the argument for investing, showcasing the potential for double-digit returns over an extended period.
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Illustrative Example: To drive home the point, the article provides a hypothetical scenario comparing the growth of money in a savings account with a 4% return to that in a brokerage account with an 8% return over 30 years. This example vividly demonstrates the substantial difference in accumulated wealth over time, encouraging readers to consider the potential benefits of investing.
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Diversification through ETFs: The article acknowledges that not everyone may feel confident in picking individual stocks and recommends exchange-traded funds (ETFs) as an alternative. This introduces the concept of diversification, where investors can spread risk by investing in a broad market index rather than individual companies.
In conclusion, the article adeptly combines the principles of financial security through emergency funds with the potential for wealth accumulation through strategic investments, providing a well-rounded perspective on managing personal finances.
