Say you’ve got a little extra cash. Now you have to decide whether to save or invest it. The answer, surprisingly, doesn’t come down to how much money you have. These days, when you can jump into investing on an app with no transaction fees and low ongoing costs, you don’t need to have a big, round number before you can invest.
“The key number is time, not a dollar amount,” says Stuart Ritter, retirement insights leader at investing company T. Rowe Price. The simple rule: If you need the money in the next three years, then save it ideally in a high-yield savings account or CD. If your goal is further out, or you don’t have a specific need for the money, then start thinking about investing in something that will grow more, like stocks or bonds.
Time horizon is important to consider because it comes down to risk. When you put money in a savings account, you’re guaranteed to maintain the balance you deposited, plus interest, and the funds are FDIC insured in the unlikely event your bank ends up failing. Most importantly, you can use the money anytime you want without worrying about losses.
And while it’s not always the case, interest rates on savings accounts—particularly high-yield savings accounts from online banks—are quite high right now, averaging 5 to 6% at some institutions. (Rates will inevitably fall at some point, but you’ll almost always be better off with your cash in a high-yield account than a traditional one.) CDs, or certificates of deposit, and money market account rates are also high, historically speaking, and are currently beating inflation.
Still, investing could net you more—but it’s never guaranteed. While the S&P 500 offered 20%-plus returns in 2023, in 2022, there was a 19% loss.
So how do you decide what’s best for your money and goals? There are dozens of different accounts and financial products to choose from. We talked to financial advisers about each one—and when they’re best used. Read on to find out more.
Save money you need this month
Your strategy is: Saving
The tool you need: Checking account
Here’s what to do now: Put money for your day-to-day spending and bill-paying here. “That money should be your transactional monthly spending, but not much more,” says Mike Reust, president of Betterment, a registered investment firm. But you also don’t want to play it too close to the edge and incur any fees for overdrafting. Even as many banks have scaled back on onerous charges for not having enough cash to cover your purchases, there may still be some penalties. The key to this is to track your budget, either with a do-it-yourself budgeting method or a budgeting app that can help you keep track of your finances, and then assume you’ll need to have at least 25% beyond your monthly needs just to make sure you can cover your checks.
Save for emergencies and unexpected costs
Your strategy is: Saving
The tool you need: High-yield savings account
Here’s what to do now: Savings accounts are the right place for your emergency fund and any unexpected costs that might arise. “Savings should be liquid accounts that allow you to overcome deductibles, unexpected repairs, market declines or avoid debt for purchases,” says Keith Chapman, president of financial planning firm The 818 Group in Richardson, Texas.
Most financial professionals recommend having at least three to six months’ of expenses stowed away for emergencies (in case you lose your job, for instance).
People with unpredictable income or who are close to retirement may want additional savings. “Early retirees, especially, like to have up to two years of cash on hand,” says Rose Swanger, a certified financial advisor from Nashville, Tenn. That’s because they have less time to wait for markets to rebound. If retirement is much farther away, you may want to keep a minimum in this account, and invest more for the long-term.
You should also automate your savings, which is a powerful psychological tool. (Just make sure to check your rate periodically against other banks, as you might be surprised at how much rates can fluctuate.) You can instruct your employer to direct a portion of your paycheck into a savings account, or you can set up an automatic deduction once it hits your checking account. “Money you don’t see is money you don’t spend,” says Swanger. She recommends keeping your high-yield savings account at a separate bank from your checking, so it’s even further separated from your regular spending. (This may be tough if you like to see all your money in one place, though.)
If you’re shopping for a new account, see Buy Side from WSJ’s picks for Best Savings Accounts for recommendations.
Save for big expenses in a few years
Your strategy is: Saving
The tool you need: CDs, money market accounts
Here’s what to do now: If you’re planning on buying a house in a couple of years, you’ll of course want to do something different with your money than if your goal is to pay for your child’s college in 18 years. Again, it’s all about your timeline. For an interim goal that is longer than just emergency savings, Nolte suggests considering a certificate of deposit that you buy as you save up for individual purchases like a new car or a big trip.
You can open an account online with a few clicks directly from most banks or investment brokerages. Your money will get locked in for the time frame you select, from three months for up to 10 years. In exchange for keeping your money untouched, you’ll get a guaranteed rate of return—usually one much higher than a traditional savings account will offer you. If you’re worried about accessing your money in that time period, consider building a CD ladder. This involves dividing your money up into different CD lengths, so one is always maturing within a few months. At that point, you can choose to cash in or reinvest the funds in a new CD.
You can also consider a money market account, which offers a high interest but doesn’t lock in your cash, as CDs do. “Money market accounts are a great tool to use in the transition from saving to investing,” Chapman says.
Invest money you need for long-term goals
Your strategy is: Investing
Tools: Brokerage account or robo advisor
Here’s what to do now: For long-term goals, such as covering a child’s college education, investing can be a good choice.
Your first step should be to assess your feelings around money and risk. You can take a risk tolerance survey to match your psychology to your strategy. Nolte finds this question useful: “Would it bother you more to have 100% in cash and see the market go up, or have 100% in the market and see it go down 29%?”
Knowing your risk helps you choose a portfolio, which could be 60% stocks and 40% bonds, for instance, or some other configuration. “If you’re 22, your time horizon for retirement is so long that what happens in a short period of time is irrelevant.” says Ritter. “You’ve got 40-plus years, so it all gets invested in stocks.”
Most investing, just like savings, can be done with a few clicks online. You put in the ticker symbol—such as VTI for the Vanguard Total Stock Market Index Fund ETF, one of the most popular exchange-traded index funds—and hit buy. If you’re wary of investing on your own, most investment services firms offer robo advisor services, which will assess your financial picture and suggest a mix of investments for you, or access to professional advisors. Fees will vary based on the service and your account balance.
Just make sure you’re not putting all your eggs in one basket. Diversifying your investments among different asset classes and sectors can help protect your portfolio in case of a downturn.
Invest for retirement
Your strategy is: Investing
The tools you need: 401(k), 403(b), IRA
Here’s what to do now: If you’re working, make sure you’re using an account like these to save for retirement. The goal is to fill your 401(k), or other eligible workplace plan like a 403(b), and contribute at least as much as your company matches, says Nolte.
Consider setting up the feature that automatically escalates your contribution level every year, usually by 1%. Anything you don’t have to think about will help you. “If the boss matches you at 4%, then save at least 5%—that’s one day’s lunch money,” says Swanger. “When I get clients to do this, a year later, they don’t even feel they’re putting money into saving.” She adds: “That’s when I say, then increase it by 2% or even 3%.”
If your company doesn’t offer a plan and you have earned income, you can start your own IRA or Roth IRA at an investment firm and invest up to the yearly limit set by the IRS. There are also various options for self-employed retirement accounts that have higher limits.
Should you seek professional advice?
While you can certainly go it alone based on the above advice, in some cases, seeking more personalized guidance from a professional might be smart, too. Experts say you’ll typically want a pro’s help if you’re going through major life changes (marriage, having a child, etc.), you want a foolproof retirement plan or you just want reassurance that you’re making the right moves.
If the stock market is volatile and you’re considering a major change to your investments, it might also be wise to seek a pro’s advice, Chapman says.
“A seasoned professional will tell you this is a great time to maintain and even add to your portfolio, taking advantage of depressed stock market and share prices,” Chapman says. “They’ll keep you on track and feeling good about the buying opportunities as they come up.”
Additional reporting by Aly J. Yale
The advice, recommendations or rankings expressed in this article are those of the Buy Side from WSJ editorial team, and have not been reviewed or endorsed by our commercial partners.
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