March 5, 2022

Saving Or Investing?

Eric Bank
Former Citadel Director of Business Analysis

The twin virtues of saving and investing should be the foundational components of your plan to accumulate wealth. Saving is what you do to prepare for emergencies and short—term expenses. Investing means buying risky assets that can increase in value over the long run. You need both – we have some suggestions of how to proceed.

Priority One: Your 401(k)

If your job offers a 401(k), enroll in it and contribute enough to receive the maximum employer matching funds. For example, your company might match your contributions up to 5% of your salary. So, if you earn $40,000, you should contribute at least $2,000 per year to your 401(k). You can (and should) contribute more, but first, you must take care of savings.

Priority Two: Savings

Your savings accounts must be safe. Virtually all banks and credit unions insure savings up to $250,000 per depositor, per insured bank. You won't need to save nearly that much, but your immediate goal should be to establish an emergency fund that can pay up to six months of your expenses. Augment your savings with the cash you'll need to spend on big-ticket purchases in the next five years. 

The problem with savings is that the returns are puny, although they are also guaranteed. Inflation is starting to puff up savings account returns, but not enough to make you rich. Look for insured accounts, including certificates of deposit, with the highest annual percentage yield (APY) and no monthly fees. Online banks are an excellent place to start.

Priority Three: Investing

You're ready to start investing if you've enrolled in your employer's 401(k), met your savings goals, paid off high-interest debt, and have an investment horizon of at least five years. Investing in retirement accounts is a great place to start – in fact, you've already started if you enrolled in a 401(k). Contributions to traditional qualified retirement accounts (401(k)s, 403(b)s, 457s) and IRAs are tax-deductible and grow tax-deferred until you withdraw money later on. By waiting until age 59 ½, you'll avoid the 10% penalty on early withdrawals from retirement accounts. 

You might want to use a Roth IRA, which doesn't offer a tax deduction but allows you to withdraw money tax-free – if you follow the rules. In 2022, you can contribute $6,000 ($7,000 if 50 or older) to an IRA and $20,500 ($27,000 if you’re 50+) to a 401(k). The same overall limits apply whether you have one or multiple accounts.

You can supplement your retirement investments with a brokerage account. The account lets you purchase a variety of financial instruments, including stocks, bonds, futures, options, warrants, foreign currencies … the list is almost endless. You can attempt to beat the market by selecting your own investments or settling for the average returns offered by mutual funds, exchange-traded funds, and REITs. Before plunging in, make sure you understand your contemplated investments' risk/reward tradeoffs. 

A final word of advice: Unless you are an expert, consider hiring a financial advisor to help you plan your wealth accumulation strategy while avoiding rookie investment mistakes.

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