Stepping Stones to Investing: Savings
By Gary Silverman, CFP®
In this survey of the contents of my new book, Real World Investing, we come first to several chapters of stepping stones to investing. While the book is not about emergency savings, saving money for short-term needs, or debt, these are areas of your financial life that need to be taken care in advance of or requisite to your investing plans. My focus for Real World Investing is investing, not savings. So perhaps it is a good idea to differentiate between them because doing so will give you a better picture of the two directions your money needs to go.
The difference between investing and savings is one of time and the trade-off between risk and return. With either savings or investing you are saving money…putting it aside for a later use. A good way to remember savings is to consider it “safe”-ing the money; in other words, making and keeping it safe. By safe I mean that it will not go down in value to any appreciable degree, even in the short-term. In fact, that is probably why you are “safe”-ing the money: the need for the money is a short time away and you can’t afford to lose it.
Why does time matter? Because most of the investments we will consider have the tendency to go down during certain economic events. We call these “at-risk” investments. They’re used is because while there is a potential for a short-term downside, what you are really after is the long-term growth that they provide. But what if you don’t have a long-term? What if you need the money tomorrow or next year? Having that sort of money in at-risk investments is akin to gambling. If you have a bad spell in the market, you might not have time for the investments to recover their value before you need to spend the money.
For example, let’s say that in the year 2007 you had $30,000 saved up for a car you were planning to buy in 2009. While you could get a quite adequate car for that amount, you knew that the stock market averages around 10% each year in return. Well, in a couple years that $30,000 could be worth more than $36,000…you could get a nicer car. So you put your car savings into the stock market. 2008 comes around, and two years later you are left with less than $15,000.
That is why you want safe investments (like savings accounts) for short-term goals. You give up long-term returns for safety. That’s the tradeoff. Bank accounts, after all, don’t average 10% a year. That’s a fair tradeoff as you don’t have the time to wait. Yes, you might earn next to nothing on your money…but at least it will be there when you need it.
More stepping stones to investing next week.
A version of this article was published in the Wichita Falls Times Record News on December 4, 2016.