Perhaps one of the first financial lessons you were taught as a kid was when your grandma handed you a birthday card with money in it. You were so thrilled at the thought of having something that held seemingly endless value. The world, and everything in it, was now available to you simply for living another year. Imagine what could happen at your next birthday! You open the card and peek inside, and for some reason they always tend to say, “Don’t spend it all in one place! Save some of it.” Talk about a party pooper! With this money, there are so many things you could do and so many things to buy, who in their right mind wouldn’t enjoy it now? Did you ever listen to this advice?
It’s no secret that saving your money for a rainy day or for some specific goal is a sensible thing to do. After all, you probably heard this sage advice time and time again throughout your upbringing, or worse, maybe you have told someone else the same thing! *Gasp!* But what about investing? It’s also a known fact that if you want to see a larger return over time, investing your money is the smarter method. But, when exactly do you invest? How much should you invest? And how much should you keep in your savings account?
It’s important to understand a few key details about what makes saving different from investing. First, I will clarify that the term saving describes the act of saving money, as opposed to savings (with the s) which describes money you have saved up. (I will further clarify that your savings includes cash AND investments, whereas investments do not include cash.) Saving is putting cold, hard cash aside and depositing it into an extremely safe and liquid savings account. (Accounts offered by banks and credit unions are federally protected by the FDIC and FCUA, respectively.) Investing is the process of using money to purchase an asset that is expected to generate a return over time. For us at BOLT, we are mostly talking about mutual funds and ETFs that buy stocks and bonds.
In most cases, investing in the stock market is a viable option for financial goals 5 or more years out. On the longer side, retirement is the most common long-term financial goal, but you also might have plans in the future to start a business, buy a second home, pay for your child’s college education, or maybe you just want to earn passive income. The key terms for investing are growth and income. It’s important to take advantage of growth in the economy for longer time horizons, especially if you still have ample time to recover from the ups and downs in the market. There is some risk involved with investing, but you should know that since 1950, the stock market has returned an average of 19% in any given 10-year rolling period.* When investing, be sure you are also keeping a healthy cash savings account balance in case you need access to funds immediately. Ultimately, you should be maintaining both types of accounts at any given time.
Having money readily available is necessary for daily living. It’s common that you’ll need money sooner, rather than later, for large purchases, an emergency fund, a vacation, or for when your car needs new tires every few years. A savings account will protect your money from decreasing in value. Though you will earn a small amount of interest, the interest alone shouldn’t be the reason to keep cash handy in a savings account. The key term to remember is liquidity. Your cash savings is money easily available to use for some purpose in the near future. However, your savings account can grow too large, putting you at a disadvantage. When your cash savings exceeds what is necessary for your short-term and mid-term goals, it’s time to transfer the excess to your investment account to better serve you. Holding onto too much cash diminishes the purchasing power of those dollars over time due to inflation. Consider that in the year 1999 a movie ticket cost about $5. Now, that same $5 can hardly buy you a soda. Your savings account balance will never decrease, but what you’re able to buy with those dollars will.
Let’s answer the questions I posed earlier:
Q: When do you invest?
A: Always! Consider retirement and other financial goals more than 5 years away. Also consider the stage of life you are in. You might be just starting a new career or have teenagers at home. In any case, you should always have a steady stream of money going both into a savings account and an investment account.
Q: How much should you invest?
A: The amount you invest should correlate to your desired outcomes and your current cash savings balance. All of your savings goals should be taken into consideration. You don’t want to invest everything but, you also don’t want to keep everything in cash.
Q: How much should you keep in your savings account?
A: Keep enough money in your savings account for whatever short-term goals you have. If you were to unfortunately lose your job, or get injured, do you have enough to pay your bills for 3-6 months? Do you have any large purchases coming up? Once your savings account grows to a level that meets those short-term and mid-term needs, transfer the excess to your investment account to see that money grow. This dollar figure will be different for everyone!
Keeping money in a savings account is the best way to put money away, separate from your day to day spending account, but close enough within reach so you can use it when you need at a moment’s notice (liquidity). Investing is crucial for longer term goals and gives you the opportunity for growth & income. Our advisers help with examining your monthly income and determining how much you need in cash savings versus investments to achieve your stated financial goals. (This is a key component to our Financial Planning process!) Knowing how saving and investing work will now lead you to a new phrase when giving a cash gift to a younger child: “Don’t save it all in one place.”
*JP Morgan Securities, Guide to the Markets, July 31, 2019, page 63.