When you have extra money, you have to decide what to do with it. This is a good problem to have, but it can still be a complicated question. Specifically, you will want to make an informed choice about whether to save it — which could mean putting it into a high-yield savings account — or invest it.
Before you opt to move your money into savings or transfer it to your brokerage firm to invest, there’s one key question you must ask yourself. Here’s what it is, along with some details about why the answer to this query will determine where your cash should go.
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You must ask this to decide what to do with your cash
The one key question you must ask yourself when deciding whether to save or invest is what your timeline is for needing the money.
See, investing can provide you with the chance to earn better returns. The S&P 500 index fund, which is widely viewed as a barometer for the stock market as a whole, has reliably produced 10% average annual returns over the long term (before inflation).
That’s a much better rate than you could get by investing even in high-yield savings accounts. While you could perhaps get around 4% right now when interest rates are high, savings account yields have been much lower in recent years. And, even if you did manage to consistently earn 4%, that’s a lot less than 10%. In fact, $5,000 invested at 4% over a decade would net you $7,401.22, while you’d have $12,968.71 if you invested the same $5,000 at 10%.
However, investing also carries risk. While the S&P 500 can be expected to earn about a 10% average ROI over time, it could go down dramatically over the course of a single year, sometimes declining by as much as 20% or 30% or more. While this could balance out since in some years it will go up well over 10%, you need to be able to leave your money alone for a long time when you invest in order to reduce the risk that you’ll buy high and sell low.
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If you cannot leave your money invested for around five years or so, you are better off putting money into savings. Yes, you’ll have to accept lower returns, but you will be confident that the money will be ready for you when you need to withdraw it — and you won’t be looking at a lower account balance than you started with.
Making the right choice about where to put your funds is important to minimize risk and maximize returns
Ultimately, by considering your timeline for when you will need the money, you can decide if you can afford to take a calculated risk for better returns or not. Don’t make the mistake of investing funds you need for the short term or saving funds you’ll need in the long term or you could end up regretting it.
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