Whether you’re in your early twenties and just out of college, or you’re a thriving professional just a few years away from retirement, it’s always a good time to think about your growing your nest egg. There are a number of ways to do that, and Central Willamette Credit Union is committed to helping you understand each of them. Two of the most popular ways to grow your money for retirement are through saving and investing. We’ll go over the pros and cons of each to show you the differences when it comes to saving vs. investing.
Which Is in Your Best Interest?
The first thing to know about investments is that they come in many forms. Mutual funds, stocks, and real estate are just a few examples of the many types of investment opportunities you could pursue. Essentially, an investment is anything that’s expected to bring you a return on your money and help it grow over time.
There’s something in the financial world known as compound interest. Compound interest can work for or against you. For example, if you take out a loan, the interest will cause the principal amount borrowed to grow so that you wind up owing more money over time. But on the other hand, compound interest can work to your advantage.
Let’s look at the annual return rate of the S&P 500, a stock market index that tracks the stocks of 500 of the largest companies in the US. It’s generally viewed as a good indicator of how well the market is performing. Historically speaking, the S&P 500’s annual compound rate of return is roughly 10 percent.
Now, let’s look at an example. Let’s say you’re 35 years old and decide that you want to start preparing for retirement by investing in mutual funds. You invest a modest $10,000 to start out, and you don’t contribute any additional money over time. Assuming a 10 percent compound rate of return, by the time you hit 65, you’ll have close to $175,000 saved for retirement. A nice amount, but not necessarily enough for a long retirement.
So let’s look at the same example again. You’re 35 years old when you make an initial investment of $10,000, but this time you contribute a monthly amount of $200. You do this faithfully over the course of 30 years. At the end of that 30-year period, your initial $10,000 investment will have grown to about $570,000.
Of course, the earlier you begin investing, the more your money will be able to grow. That’s because compound interest’s best friend is time. Likewise, the later you begin to invest, the more aggressive you will have to be with the amount of money you set aside. If you want to see how compound interest could work in your particular situation, try this compound interest calculator. You can plug in the numbers that apply to you and adjust it to see how much you’ll need to invest in order to get to your desired retirement nest egg.
Saving, on the other hand, refers to setting aside a certain amount of your income, typically to obtain a financial goal. It could be for something small, like saving for an annual vacation, or for something larger, such as saving for retirement. If you’re doing the latter, it’s typically recommended that you save 10 to 15 percent of your annual income. So if you make $50,000 a year, you’ll want to set aside between $5,000 to $7,500 a year for retirement. Assuming your salary doesn’t change, setting aside $7,500 a year, or $625 a month, would net you $225,000 over the course of 30 years.
Can you make compound interest work for you when saving? Yes and no. It’s possible to open a savings account with an interest rate that will help you grow your money, but typically, interest rates on savings accounts are much lower than those earned in the stock market, for example. A typical annual yield on a savings account, for instance, may be 0.05 percent. Based on this interest rate and our example above, you would wind up with about $226,640 at the end of the 30-year period.
Now let’s take a look at saving vs. investing with the previous example. If we start with an initial amount of $10,000, set aside $200 a month and continue to save over the course of 30 years with an annual yield of 0.05 percent, we wind up with about $82,675. That’s significantly less than what we accumulated when we were investing the same amount with a compound rate of return of 10 percent. That’s the power of compound interest.
Worth the Risk?
So if that’s the case, you should just invest all your money, right? After all, who doesn’t want to wind up with the most amount of money possible for retirement? Well, not so fast. Remember when we said that compound interest could work for you or against you? That’s the case with investing as well. You have to be able to weather those ups and downs in what can sometimes be a volatile market. Sometimes those volatile years occur back to back, meaning you can lose money through investing just as quickly as you were able to earn it.
Let’s take another look at the S&P 500. If you take a look at this chart, you’ll see that just last year, the market saw a negative return. But looking back to the early 2000s, the market took even more of a hit. Investments saw a negative return of roughly 9, 12 and 22 percent in 2000, 2001, and 2002, respectively. Jump ahead to 2008, and you’ll see that the market saw an astounding 37 percent loss. That’s why investing can be risky.
Saving, however, is relatively safe. You can grow your money in your bank account without fear of loss. If your money is kept in a federally insured bank or credit union, you are insured up to $250,000 per financial institution. Saving provides financial security for your future without the risks that often come with investing.
There are other noteworthy differences when it comes to saving vs. investing. You may have heard of the term liquid asset. Cash, for instance, is a liquid asset. When you save for retirement, you have that money at your disposal to be used for whatever purpose. However, investing means that your money is sometimes tied up and not readily accessible. This is what we call a non-liquid asset. If you invest in land or real estate, for instance, it could take quite some time to sell that property and convert its value into cash. That’s another factor to consider when deciding whether you want to save or invest for retirement.
At Central Willamette, they are committed to helping you find the best solution for you. They offer a variety of savings and investment accounts to help you build wealth for the future. We’ll help you find the solution that best fits your needs. There are many factors to consider when it comes to retirement. Schedule an appointment with one of their financial advisors so they can put you on the path toward an early one.