Using Savings to Invest
Saving is an important component of any sound financial plan. Savings happen when you spend less than you earn, whether that’s because you have an unexpected raise or because you’re curbing your spending habits. This can mean anything from making a plan to pay off debt to actually setting up separate accounts to act as savings funds that cannot be touched.
For many who have gotten their savings accounts growing successfully, investing becomes a natural next step. Investing is a way to put savings to work for you, to continue to grow them without added work on your part. Simply put? It puts your money to work for you.
Investing doesn’t have to be the stereotypical gambling like high risk investments either, there are a full range of risk levels for investments (each with their own level of reward as well). The point is that investing can be great for risk levels of any level, in fact just a low risk investment can be enough to substantially grow your account without having any added work on your part whatsoever.
Let’s look at some examples of how to put your savings to work, and see the power involved in investing.
|Example one: Amelia
Amelia usually has an average of $3,000 in an everyday bank account that only pays interest of 1% on a minimum account balance of $5,000. In short, her savings currently earn no interest. At any one time, Amelia generally needs access to less than $1,000 of her account for everyday expenses. If her spare $2,000 in cash remains in the everyday bank account, Amelia won’t lose any money, but it’s certainly not generating her any interest income either. She decides to transfer $2,000 into a high-interest bank account earning 4%, which means her savings earn $80 a year rather than zero dollars. If Amelia does nothing, her money will earn no interest.If you replace the $2,000 with $20,000, then doing nothing means receiving $200 in interest (1% interest in everyday bank account on balances above $5,000), while redirecting the cash to a high-interest bank account means a hefty $800 a year on the $20,000 investment. The more money you have saved, the greater the financial consequences by not investing that money. For example, if Amelia had $200,000 in savings and chose to leave her money in the everyday bank account, her cash would earn $2,000 but if she redirected those savings into the high-interest bank account, then those same savings would earn $8,000 a year rather than $2,000 a year.
*Amelia’s everyday bank account pays 1% interest on account balances of $5,000 and no interest on balances lower than $5,000.
Inflation is the term given to describe the increasing cost of living. It ensures that money decreases in value over time. If you stashed $40 away today, you’d quickly find that it would be worth a lot less over time. The reality of inflation almost makes investing a necessity, as if you just save money (without putting into investments to grow it) then it will devalue itself over time.
Returns are the money you get back from your investments. They can come in a variety of forms, from interest on a bank account to shares in the market or property value and rent.
How will you know when you have a good investment? When it’s positively earning, that is to say: when the value on your investment is higher than inflation. When inflation is higher, you’re losing purchasing power on your investments, you’re basically losing money. The goal here is to try to keep your returns positive, so that you can know when to stick with an investment and when to drop it.
Let’s look at an example of a positive investment.
|Example two: Amelia goes a different route
Amelia (from Example one above) has $2,000 to invest and she decides to deposit the amount in a high interest bank account earning 4%. The interest she earns is $80 for the year.If inflation, that is the annual rate of price increases, is 4%, then the real return on Amelia’s money is zero. You deduct the effect of inflation from the return you receive to work out the real rate of return on your investment. Amelia may have $80 more in her account, but the purchasing power of $2,080 is effectively worth the same as $2,000 a year ago.If, however, inflation is running at only 2%, then you deduct only $40 from your interest income to work out your real return of $40 (2%).If inflation is running at 10% (which hasn’t happened for quite a few years), you need a return of at least 10% to retain the real value of your investment.
The final thing we’ll say about investments is not to forget taxes. You pay taxes on all money you earn, and this includes investments. Consult an accountant to get a better understanding as to what taxes you will owe on your gains.
This article has illustrated the power of investing, and why it may be more of a necessity than an option. Positive returns are a great way to keep your cash earning, rather than deflating in value with inflation. Just make sure you do your research first, and you’ll be on your way to successful investing in no time.