"A penny saved is a penny earned," goes the old adage. We're guessing that quip was created in the days of when a savings interest rate actually outpaced inflation. In the modern economy, you may actually lose money by socking it away into a bank savings account.
The savvy saver knows saving isn't all that it's cracked up to be today. What is the alternative - the bed mattress? Hardly. Most people would spend that money, and even those who didn't would still be subject to inflation, fluctuating interest rates and volatile currency exchange rates.
We are fortunate to live in an era when a huge amount of financial information is commercially available. This is the data that the rest of us paid financial elites to access for us in previous generations. Well, the paywall is gone, but the responsibility for all of us has now increased. Every person must now take it upon himself to understand when to save and when to invest.
Let's be clear - even the most conservative risk tolerance is no reason to forego investing. Treasury bonds that are created specifically to outpace inflation are considered the safest investment in the world. Many people completely overlook or forego these just because they hear the word "investment" and immediately think of "possible loss."
No, personal risk tolerance must be a function of knowing the basics of all the financial tools that are available to you. Once you learn the real risk that is associated with using those tools, you can make an informed decision about how much of that risk you want to take.
Let's take a look at the basic tiers of savings and investment vehicles that everyone should know about.
We define the savings vehicle as a vehicle in which the saver trades immediate access to money for a stated fixed interest rate on that money.
Savings vehicles may also be referred to as cash equivalents because of their proximity to a fixed cash value at a certain point in time.
We define the investment vehicle as a non-cash equivalent vehicle that assumes some variable market risk and has the potential for a higher rate of return than fixed-rate savings vehicles.
It is essential to know what market conditions are affecting important metrics such as interest rates for fixed investments. Those same market conditions may also play a role in the individual performance of volatile securities. This is the kind of information that consistently changes and takes a lifetime to learn, but every person should understand the basics. Being able to interpret certain macroeconomic factors will determine how you spread your money around between savings and investment vehicles.
When interest rates are considered low, money becomes easier for investors to borrow. When money becomes easy to borrow, speculators enter the market and volatile investments gain volume that may temporarily stabilize them. There are many theories, but ideally, this is how lower interest rates affect the market for the money.
When interest rates are considered high, money tends to flow towards fixed investments. During this time, savings accounts and other fixed yield investments will give their highest rates of return. Conservative investors who are looking for a way to park money without having to think about it will take advantage of macroeconomic conditions like these. Money also becomes more difficult to borrow, because failed speculative investments now incur a higher penalty.
You should consider the current and future interest rates that will coincide with your investment period if you are looking to delve into financial vehicles for any specified amount of time.
Consider the scale of the savings or investment vehicle before moving into it. Scale can make the difference between a profitable investment in a failed one.
Most investments incur fixed costs that must be overcome before a profit can be realized. For instance, buying one share of a $10 stock is probably not a good investment even if that stock achieves an outrageously good return of 40% over the next year. Because the fixed cost of placing a stock order is anywhere between five dollars and $35, you would need a much bigger (virtually impossible) rate of return to see a profit on the purchase of one stock. Alternatively, the purchase of 1000 shares of the same stock would yield quite a good profit, as the fixed cost of that order is still the same five dollar to $35 fee.
Conversely, you may actually be able to achieve quite a good return on a low-interest fixed savings account if your initial deposit is high enough. A 2% annual return on a $10 million investment yields enough to support most lifestyles. The concern here is not necessarily the percentage yield, but the total amount of money generated. At the same time, that 2% rate on a $1000 savings bond may not generate enough total income to be worth it to you. This is something that only you will know as you assess your personal goals.
The market risk that investors incur when investing is somewhat tied to the amount of education that an investor has about a certain investment. There is no such thing as a "right" or "wrong" trade in the stock market without considering the entry point, the ability to leverage the initial purchase, and timing the exit.
Understanding what these variables mean involves education about the underlying investment and stock market strategies that apply to every security that an investor might purchase. The same goes for other investments such as real estate or business investments. Although an industry can be quite profitable, an individual investor can limit his or her success because of a lack of education about that industry. In this case, it would be better for that person to park money in a fixed rate savings account that incurs no punishment for a lack of knowledge about the market or any particular industry.
Keep the above in mind when determining how to utilize your money. Neither saving nor investing is a catchall solution that will solve all of your problems. Properly managed, however, both of these vehicle types have the potential to provide stability and even wealth.
Most importantly, do not think that you have to take on the responsibility of understanding money alone. Even the best investors have advisors (ask Warren Buffett). Make sure that you take advantage of all of the resources available to you at Seacoast Bank. Give us a call or an email for a consultation about any financial questions that you may have.
To learn more about your options, call us now or schedule an appointment with an advisor.
Topics: Invest & Retirement