Short of winning the lottery, investing is the fastest way to grow your wealth. But the risk involved and the overwhelming number of investment possibilities leave some wondering if there are other ways to reach financial goals.
There are, but they have their own drawbacks. Below, we'll look at a few different options to help you decide where you want to keep your savings.
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Keeping your savings in a traditional savings account
Savings accounts enable you to grow your money without the risk that comes with investing. They also have fewer limitations on when you can withdraw funds than do popular retirement accounts like 401(k)s and IRAs. But it'll take a lot longer to grow your money into any sizable sum with a savings account.
The average savings account annual percentage yield (APY) is just 0.06%. If you contributed $500 per month to a savings account with a 0.06% APY, it would take approximately 159 years to save $1 million. If we look at a slightly less unrealistic example -- saving $500 per month for 40 years -- you'd only have about $243,000, and $240,000 of that would be your personal contributions. That means in 40 years, you'll only have earned about $3,000.
Another problem you might run into with a savings account is the FDIC insurance limits. FDIC insurance protects your money up to $250,000 per person per bank against bank failure. If you keep more than this in a savings account and your bank goes under, you could lose the extra. You'd have to spread your money around among multiple banks in order to keep large sums safe.
Keeping your savings in a high-yield savings account
High-yield savings accounts are savings accounts that offer an APY that's well above the national average. These APYs were around 2% prior to the COVID-19 pandemic, but the recession has driven them down to about 0.50%, on average.
If you set aside $500 per month in one of these, it would "only" take 122 years to become a millionaire. And after 40 years, you'd have a little over $265,000. It's possible you could end up with a little more if APYs increase, but it's equally possible they could decrease over time, leaving you with less. Even in favorable circumstances, it's unlikely you could save $1 million with a high-yield savings account alone.
Investing your money in a brokerage account
Investing offers returns that are much higher than even the best high-yield savings account APYs, on average. That means you can reach $1 million in savings while contributing only a fraction of that yourself.
Let's return to our example of a $500 monthly contribution over 40 years. If your investments earn a 10% average annual rate of return, you'd end up with close to $1.4 million despite only contributing $240,000 of that yourself.
It's true there is a risk of loss when you invest, but you can reduce it by spreading your money across many investments. Index funds are a simple way to do this with one purchase. These are bundles of stocks you purchase together, and they tend to offer some pretty strong returns with minimal fees.
It's likely that you will lose money on some of your investments in the short term, especially if you're heavily invested in stocks. Stocks experience a lot of short-term fluctuations, but over the long term, many top companies see their stock share prices trend upward.
If you're prone to making emotional decisions with your money, it might be best to automate your contributions and avoid checking your portfolio every day. Checking once or twice a year and whenever you experience a major life change is plenty when you're still decades away from retirement.
Investing, like anything, can feel a bit intimidating when you're new to it, but as you become more experienced, you'll grow more confident in your ability to make smart decisions with your money. Plus, the sooner you begin investing, the sooner you can reach your financial goals. Just make sure you're following the tips above so you can turn a profit without exposing yourself to too much risk.
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August 01, 2021 at 04:02PM
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