James Lambridis, Founder/CEO
April 1, 2021
Should you save your money or invest it? This is an age old question, and a good one at that. Many Americans aren’t sure what to do with their leftover cash after all of their basic expenses have been paid. One thing we do know, is that you should certainly make your money work for you. Cash does you no good sitting in a checking account or under your mattress. For centuries, compounding interest has been the vehicle that has made many people fortunes. If you don’t take advantage of this, you are doing yourself a disservice. However, different situations call for different saving and investing strategies. Many factors need to be taken into account, such as your age, income, and risk aversion level. Let’s take a look at when it makes sense to save first, when it makes sense to invest, and how you can accomplish both simultaneously.
If you are a recent college graduate, just starting your career, and/or potentially looking to make a significant investment in a home or other piece of real estate, you should focus on saving before investing. According to TIAA (Teachers Insurance and Annuity Association of America), the rule of thumb is to save 20% of each paycheck. TIAA also recommends a maximum of 50% should go toward necessities, while 30% should go toward discretionary items. While 20% is recommended, you should try to save as much as you can. According to a recent poll, nearly 70% of Americans have less than $1,000 stashed away. In addition, 45% have nothing saved. Most are not even able to cover an unexpected $500 expense. The last thing you want to do is have to resort to taking out loans or using credit cards to cover an emergency expense. This is why saving is the key to your long term financial health.
Next, you need to figure out where to put the cash that you have set aside for savings. While everyone should have some type of basic checking account for everyday transactions, the bulk of your funds should go elsewhere. In the current highly competitive banking industry, there are many options that give you the opportunity to earn high yields on your money and give you the flexibility to easily transfer/withdraw your money as you wish. While your local small town bank or credit union is better than larger banks if you want to maximize your interest income, there are now many online only savings accounts that offer the same, if not higher returns.
If you own a home already and don’t plan on making any large purchases that will require a substantial outlay of cash, you should focus on investing your money. While DebtMD isn’t in a position to give investment advice, what we can tell you is that simply investing in a fund that tracks the S&P 500, NASDAQ, or any other index will produce great returns for you over the long haul. There are many ETF’s (exchange traded funds) that can accomplish this. For people with minimal knowledge of the stock market, this is the best way to go about investing. Mutual funds are another great investment tool where you can allocate your money to whichever industries you wish to invest in. However, make sure you are aware of the risk you are taking, especially in today’s uncertain economic climate.
Where to Invest
In today’s day and age, robo-advising is becoming more prevalent than ever. If you are not familiar with these, robo-advisors use computer algorithms and advanced software to build and manage your investment portfolio. When choosing your allocation of investments, the robo-advisor will take into account your risk tolerance, goals, and investing preferences. For this reason, it is a “set it and forget it” type of service. Another benefit is that there is a very low minimum investment relative to other investment vehicles. You can get started with as little as $500, and sometimes even less. Some services you may want to look into if this type of investing interests you are Betterment, Wealthfront, and Acorns, which are all great for novice investors.
DebtMD had the chance to speak with Paulina Likos, investing reporter with U.S. News & World Report. Paulina gave us some valuable insights on saving and investing, as well as general advice on how to get started.
“A useful tip for saving and investing effectively and consistently is to automate your investments,” says Likos. “The first step would be to put together a budget, which can help you determine how much to allocate toward your savings account and investment vehicles.”
“Once you set up your brokerage account, you are then able to manage your money automatically. Having your finances on autopilot can be a useful best practice that helps make sure you are on track with your investment goals.”
For those who are new to investing, Likos advises to “start by opening a brokerage account and seek out investment vehicles that align with your risk tolerance, time horizon and investment goals. This will require some planning and research but there are many online resources that can guide you toward making the best investment decisions.”
Her most important tip, however, is to start early. “The most important thing is that you start early to take advantage of time in the market and stay invested long-term to allow your investments to compound in growth.” Compound interest is a fool-proof way to watch your money multiply even if you are a beginner at investing.
How to Save and Invest
Ideally, you should do your best to save money and invest at the same time. This is how you will really start to see your money grow and accumulate wealth. People have different ideas as to how much you should save and invest, but my recommendation is to save 20%, and invest 10%. While this may seem a bit ambitious, it can be done. If you have a 401K or IRA through your employer, you can have the money automatically deducted from your paycheck and not have to worry about it. Also, most employers offer some type of match when enrolling in one of their retirement plans. If you are doing it manually, I like to stick to the 20/10 rule. This leaves you with 70% of your income for necessities and discretionary purchases. If this is difficult, you can go down to 5% of your income invested if need be. NEVER sacrifice your savings. If one needs to be sacrificed to make ends meet, it should always be the money you intend to invest.
In the end, everyone’s financial situation is unique, and while we can give saving and investing rules and percentages to aim for, it is always going to be subject to change. Life is full of unexpected surprises (and expenses). For this reason, you should always be willing to change your allocations as needed. Know that this article is designed to be a guide, not a rigid set of rules.
The decision on whether to save money or invest it depends on your unique situation; where you are in your life and what your main goals are.
Holding everything else equal, always SAVE before INVESTING.
Ideally, you should try to do both at the same time. Shoot for saving 20% of your income and investing 10%.