Question of the Week:
How much should I Save vs. Invest?
This is a great question and a very common dilemma.
Putting money in a savings account gives you easy access to your money and keeps it safe, but often lacks the potential for growth.
On the other hand, investing gives you the opportunity for long-term growth, but has more volatility.
So, how do you find the balance? That will be unique for each of you, but here’s how my wife and I think through this:
First, we keep our emergency fund full.
Initially, it took a few months, but it was quite worth it. We’ve had to use it for an expensive vet bill followed shortly by unexpected car repairs - having money set aside has been worth the effort.
We keep our emergency fund in a money market account at Fidelity. It won’t grow as much as other investments (it’s 3-4% per year), but we can get to it quickly if needed and know it won’t decrease if the stock market tanks.
Next, we filled our 401(k) matching contributions.
Each of our companies offer a 100% match of a portion of our contributions - that’s free money!
Take advantage of your company match
If you think your employer may offer this, ask them about it.
Then we thought through our financial goals:
- Do we want to buy a car anytime soon?
- When do we want to buy a house?
- Are we saving enough for retirement?
- What about vacations?
- Any other major expenses?
Once you have rough timing, you can allocate money accordingly.
Short-Term Savings
If you are making a major purchase in 6-18 months, the general school of thought is to prioritize safety and liquidity (access to your money) over higher returns.
Though the stock market offers potential for higher returns, it carries higher risks and could lose value over the short term.
For example, let’s say you were planning to buy a car in March of 2020 and had money in the stock market.
Between late February and late March, the S&P 500 dropped 34%. Not so great for your car fund.
The stock market did not recover that 34% drop until mid-August of 2020.
If you had those 6 months to wait, great. If you needed that money in March, less than ideal.
That’s why as you get closer to making a large purchase, it’s best to move the money you're planning to spend out of the stock market.
If you are comfortable with risk, maybe you pull out of the stock market a few months before a purchase, if you are more risk averse it would be reasonable to start diversifying out 1-3 years in advance.
Long-Term Savings
Now, for longer-term purchases, it may be advisable to try and grow that money with investments.
Certainly, for 15-40 year time horizons like retirement it is generally recommended to be investing.
If the stock market takes a downturn, you have more than enough time to ride it out and wait for it to rebound in the coming years.
Medium-Term Savings
The Medium-term is where it really comes down to preference.
Anything 2-15 years away, it’s going to depend on your risk tolerance.
That’s because the stock market can fluctuate a lot in a 10 year time horizon.
From 2014 to 2024, the S&P 500 averaged ~13% annual growth - a phenomenal run.
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From 1998 to 2008 it averaged 1.51% with 23% and 38% drops in 2002 and 2008 respectively - not phenomenal.
Can you stomach seeing 20-40% of your net worth temporarily wiped out? Or are you likely to panic-sell and lock in your losses?
Understanding your preferences will determine how you allocate those Medium-Term dollars.
Conclusion
Overall, personal finance is… personal. Everyone will allocate their money differently. An investment professional will be able to guide you on goals.
That said, hopefully this gives you a decent framework for how to think it through!
Next week, we’ll continue our investing series and talk about the options out there to invest your money in.
Great question from Austin B. this week.
βWant to be next week’s question? Reply to the email and ask!β
βAs with all things I discuss here, my goal is to inform and educate. This should not be taken as investment advice.
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