Saving or Invest Money in Stocks: Which is Better?
Making your money work for you is one of the most important aspects of personal finance. It can help you build a nest egg, save for retirement, or pay for some living expenses.
Two common ways that people try to grow their savings are through savings accounts and by buying stocks. The two strategies are very different. Each has different benefits and drawbacks, so choosing the right option is important.
Quick answer: Savings accounts allow your money to earn interest slowly and there's low risk of losing that money. Stocks offer high growth potential, but there's the risk of losing all the money in your stocks.
Savings Accounts Offers Safer, Slower Growth
Even so, you can generally withdraw small amounts immediately and larger amounts with a few days notice.
A savings account is a type of bank account that lets you store your money safely while earning interest. The savings account is one of the most common types of bank account, next to the checking account.
Savings accounts in the United States are super safe. It'll be tough to lose any of the money you’ve deposited in a savings account. This is thanks to the Federal Deposit Insurance Corporation (FDIC), which was created in 1933. The FDIC insures every savings account for up to $250,000. Even if the bank you’ve made deposits at goes bankrupt, you will still get your money back.
This makes savings accounts perfect for money that you cannot afford to lose. Any money that you’re saving for unexpected expenses should go in a savings account.
Earn interest on your deposits
Another reason savings accounts are a great place to store money for unexpected expenses is how easy it is to get your money back. You can go to your bank at any time to withdraw the money you’ve deposited in a savings account. By law, banks must keep an amount of money, based on how many deposits it accepted, on hand. That means the bank will be able to give you your money any time you ask.
The benefit of a savings account is that the money you place in the account earns interest. Every month, the bank will give you a percentage of the money you have deposited in your savings account.
That percentage is determined by the interest rate of the account, which is usually quoted in interest per year. So, if your savings account offers 1.00% APY and you have $1,000 in the bank, your bank will pay you roughly $10 over the course of the year.
Here are the most popular online savings accounts:
Banks are willing to pay interest on savings accounts because they can use the money to make loans to their other customers. By making a deposit in a savings account, you are effectively making a loan to the bank. The term of the loans requires that the bank will give the money back to you if you ask for it.
Banks are required by law to keep a certain amount of money on hand, based on how much money customers have deposited at the bank. That means that you don’t have to worry about not being able to withdraw your cash because the bank has loaned all of it out to other people.
Savings accounts are great for saving money that you have short-term plans for or money that you cannot afford to lose.
What Are Stocks?
Stocks are shares of ownership in a company. Shares of publicly traded companies are bought and sold on public stock exchanges. If you own stock in a business, you are a partial owner of that company. That means that you are entitled to vote on important company decisions and receive a share of the profits.
There are thousands of companies in the United States alone that are publicly traded, and you’ve heard of many of them. Disney, Coca-Cola, Facebook, Twitter, Wal-Mart and more all have stock available for purchase.
Earnings from dividends
Stocks can deliver profits to stockholders through dividends. If a company has made enough money that it does not need all of it to pay for its operation and future expansion, it will declare a dividend.
Every stockholder will receive the amount of money that was declared, multiplied by the number of shares they own. So, if you own 100 shares in XYZ Company, and XYZ has declared a fifty cent dividend, you’ll receive a total of $50. You can use that money to buy more stock in XYZ company or another company. You can also use it to pay for other things.
Profit from rising stock prices
Not all stocks pay dividends. This is because of the fact that some companies, especially newer, or fast growing ones, want to use all the money they take in to fund growth. Companies that don’t pay dividends can still make you money by increasing in value, raising the price of the stocks you own.
Over time, some companies grow, and some go out of business, meaning some companies become worth more, and others less. Since owning a stock is the same as owning part of the company, if the company grows, the value of your stock will increase. You can sell your shares of the company to make a profit. If the company does poorly, the value of your stock will decrease. This is why stocks are considered volatile investments.
You can make a lot of money if your company is hugely successful, but you can lose all of your investment if the company goes bankrupt.
Investing for the Long Run
When most people think of investing, they think of putting money in the stock market, but there’s much more to it than that. You can invest in a huge variety of things that aren’t stocks: bonds, real estate, REITs, mutual funds, and more. There’s also a wide variety of accounts that you can use to invest: brokerages, 401(k)s, IRAs, and more.
The dictionary definition of an investment is an asset that you purchase in hope that it will generate income or increase in value. By that definition, all sorts of things can be considered investments, but we’ll look at the most common financial investments available.
Stocks are shares of ownership in publicly traded companies. If you own one stock of Coca-Cola, for example, you own 0.0000000002% of the entire Coca-Cola company. While that may seem like a minuscule amount, and it is, Coca-Cola is huge. That one stock is worth roughly $40. In 2016, Coca-Cola made more than $41 billion worth of sales, so your share of those sales is almost $10. Even owning a tiny portion of a large company entitles you to a large amount of money.
As a stockholder, you can vote on important decisions the company must make. Usually, the most important vote is on the company’s board of directors. The job of the board of directors represent all the shareholders and ensure that the company is run to benefit you.
As a shareholder, you’re entitled to a portion of the company’s revenue, but the company decides how to best use the money it makes. Some of the profit will be reinvested into the company. By using the profit to expand, the company hopes to increase its value, and therefore its share price. If it succeeds, you’ll be able to sell your shares for more than you bought them.
Some companies, especially larger ones, use their profit to pay dividends. Returning to the example of Coca-Cola, out of the $10 in revenue the company made per share, it paid $1.40 as a dividend. Dividends are usually paid each quarter. You can choose to take the dividend as cash to your bank account or to reinvest it. If you reinvest your dividends, the money will automatically go towards buying more shares. By reinvesting dividends over a long period of time you can greatly increase the number of shares you own.
Stocks are risky investments. If a company goes bankrupt, your entire investment disappears and you lose all your money. You are compensated for this risk by the high expected returns of stocks. Over a long enough period of time, you can expect 9-10% returns annually. Risk tolerance is key for investing in stocks.
You can purchase bonds from companies, local governments, or countries, including the United States. When you purchase a bond, you are making a loan to the entity selling the bond. Just like loans, bonds have an interest rate, which is the amount you will make on your investment.
Bonds also have credit ratings, indicating the odds that the company will actually be able to pay you back. The worse the credit rating, the higher the interest rate must be.
Bonds are safer than stocks, but are not a sure thing, as bond issuers could be unable to make payments. The reduced risk is offset by the fact that returns on bonds are lower than stocks.
Mutual funds reduce the risk of investing in stocks and bonds by helping you diversify your investments. By buying one share in a mutual fund, you can buy partial shares in hundreds or thousands of stocks and bonds. Even if one of the companies goes under, you won’t lose much since your money is spread widely. The downside is that mutual funds charge a management fee to cover the cost of running the fund, slightly reducing your returns.
Each fund has a different strategy and goal, so choosing the right on for your needs, whether that be growth, income, or capital preservation, is important.
You can purchase real estate as an investment. Over time, real estate such as housing, office space, or commercial space tends to become more expensive. That price appreciation lets you sell for a profit down the road. While you wait for the price of your real estate to increase, you can make money by renting the space. This makes real estate an attractive investment because you can use the rent to pay the mortgage, and then some while waiting for the value of the land to increase.
Real estate is a volatile investment since you usually need loans to purchase it, and values can quickly fluctuate. Skilled and lucky real estate investors can make large sums of money, but the less fortunate can easily lose it all. It also tends to be hands-on since you need to keep the place in good repair and find good tenants.
Accounts You Can Use to Invest
There are two main types of accounts you can use to invest. Taxable accounts and tax-advantaged accounts.
Any account you open will, by default, by a taxable account. There’s no restriction on how much you can invest each year in taxable accounts. Whenever you have extra money you can use it to purchase more investments.
When you sell your investments in a taxable account, you’ll have to pay tax. Dividends, long-term capital gains, and short-term capital gains are all taxed differently, so keeping track of things and planning your sales is important.
Retirement accounts like IRAs and 401(k)s, or other accounts like HSAs and 529s are tax-advantaged accounts. That means that the investments in these accounts have special tax rules that can help you reduce your annual tax bill. Each account has different contribution limits and rules, so you’ll need to figure out which is best for your needs.
What Brings a Higher Return?
Stocks yield a significantly higher return than savings accounts do. Since 1928, stocks have given investors a 9.5% return annually, while the highest yielding savings accounts offer that kind of earnings. Over the course of years, investing in stocks rather than savings accounts can lead to earning tens of thousands of dollars more.
Consider the risk for the return
The reason for this vast difference in returns is the risk involved. The stock market can and has crashed many times before.
In 2008, the S&P 500, an index that tracks the value of the 500 largest companies in the United States dropped by 36.55%. That means that if you had $100 worth of stock on January 1st of that year, you had only $64.45 by December 31st.
If you’d kept that $100 in a savings account all year, you’d have closer to $110. Even if your bank had been forced out of business by the financial crash, your money would be safe thanks to FDIC insurance.
Diversify to reduce risk
Before you get worried about the risk of investing in stocks, it’s important to remember the effect of diversification. It is quite possible for an individual company to go out of business, and for you to lose all of the money you invested in it. It’s far less likely for a hundred companies to all go out of business together. If you purchase a wide variety of stocks, you won’t be as likely to earn huge returns on your stock, but you’re far less likely to lose it all.
It’s far less likely for a hundred companies to all go out of business together. If you purchase a wide variety of stocks, you won’t be as likely to earn huge returns on your stock, but you’re far less likely to lose it all.
Time is also an important factor, as market crashes don’t last forever. Though the stock market dropped by more than 35% in 2008, it was back to the same level by 2012, and it moved more than 50% higher by 2016. Though you can lose money in the short term, there has never been a period of time longer than fifteen years where investing in a wide variety of stocks has resulted in a loss of money. Though the past can’t guarantee the future, if you can invest for the long haul, the odds of losing money are very low.
Though you can lose money in the short term, there has never been a period of time longer than 15 years when investing in a wide variety of stocks has resulted in a loss of money. Though the past can’t guarantee the future, if you can invest for the long haul, the odds of losing money are very low.
How Should You Use
In short, you should use both stocks and savings accounts. Each is uniquely suited to meet one type of financial need.
Savings account for the short term
Savings accounts are designed to be used for money that you cannot afford to lose. You should also use one for short terms goals like buying a car or saving up for a down payment on a house.
The most important use of a savings account is to keep an emergency fund. Unexpected expenses like medical bills or car repairs can pop up anytime. Having some money set aside to deal with them so you can avoid going into debt is essential to making your savings grow.
No amount of stock or money in a savings account can outstrip the interest that you have to pay on credit card debt. An emergency fund is doubly important if you happen to lose your job since it’ll give you a way to pay the bills while you look for a new one.
Despite the fact that you earn less money with a savings account, you can never lose the money in it. That makes it the ideal place (in addition to certificates of deposit) to store money that you’ll need in the near future or just can’t afford to lose.
You can be sure that you’ll never lose money because savings accounts are insured by the Federal Deposit Insurance Corporation (FDIC). So long as your bank is insured by the FDIC, your deposits of up to $250,000 per savings account are protected. Even if the bank goes out of business, you can never lose the money you put in your savings account.
Stocks for the long term
Stocks are ideally suited for long-term goals, like saving for retirement, or building a college fund for your young children.
The significant return you can earn from stocks will greatly accelerate you towards your savings goal. You just need the time to ride out the fluctuations of the market. If you don’t plan to retire for another thirty years, it doesn’t matter if the value of your stocks falls by 50% or more tomorrow.
You can be confident that it will have recovered, and then some, by the time you actually need to use the money. In fact, a drop in the market in your early years of investing can be seen as a good thing. In a way, you’re buying stocks while they are on sale.
Not One Or The Other
Stocks and savings accounts are both important tools when it comes to growing your savings and making your money work for you. Savings accounts are perfect for short term savings and keeping an emergency fund of cash that you can’t afford to lose. Stocks are the best way to accumulate wealth over the long term, even if you might lose money in the short term.