Q&A: "Should I Invest or Save?"

Here's the question we'll be tackling today:

Hey Nicole! My name is Allie. All of this money stuff is new to me, and so I’m trying to undo years of not paying attention to my finances and take control. One of my goals right now is to grow a better nest egg for myself so I can buy a house in ten years, when I’m 40-ish. I’m trying to decide whether it’s better to create a sub-savings account for the down payment, or try to grow some seed money for the down payment in the market. I’d really appreciate any advice you could give!

Allie, before I dive into this question I highly, highly suggest that you check out my article on whether buying a house is right for you. The benefits of buying a house aren’t guaranteed like they were in the 50s and 60s, so the question of whether or not buying a house is a smart move has gotten more complicated, and isn’t a one-size-fits-all answer.

If you’re looking to grow some money across a ten-year window, and you’re under 50, I would recommend putting most of your down payment fund in the market. But, I will never make you trust me blindly. I’ll show you why investing is a smart move for you.

The reason you’re considering putting this money in a savings account is probably because some other financial expert (not this one!) told you that you could grow your money there; it’s the concept of your money generating more money through compounding interest. When it comes to borrowing money, we hate this concept. When it comes to making money, we love it.

To be brutally honest with you, you’re probably not going to find a savings account with a high APY (annual percentage yield, or, what you earn in interest). Your APY at a run-of-the-mill savings account will likely be something like 0.01%. You may be thinking: okay, that’s better than nothing? I suppose that’s true, but 0.01% is a lot closer to “nothing” than it is to “something.” Let me show you.

For easy math, let’s say you have $10,000 in your savings account. How much will you make after one year with an APY of 0.01%? Let’s crunch those numbers.

$10,000 x 0.0001 = $1

A measly $1! The total in your savings account after year one is $10,001. So generous of you, big bank.

Let’s see how this growth will change over time. Next year, you’ll be making 0.01% of your new grand total (the initial chunk of money you put into your account, plus the amount you’ve earned in interest).

$10,001 x 0.0001 = $1

So after two years, your $10,000 has earned a whopping $2. I think it’s fair to say that a 0.01% yield is not going to change your life.

Let’s explore how this growth might look in the stock market. Historically, the stock market has grown 8% year over year. Yes, we don’t need to do any calculations to recognize that 8% is more than 0.01%. But how much do those couple of percentage points change your bottom line? Let’s whip out our example again. You still have $10,000, but this time, you’re investing that lump sum in the market. Let's take a look:

$10,000 x 0.08 = $800

After your first year, you’ve made $800!

Let’s keep going. Here's what your account will look like after your second year:

$10,800 x 0.08 = $864

So after the second year, you have $11,664 sitting in your brokerage account.

So, which sounds better to you: $10,002 or $11,664? I’m feeling pretty confident you want the 11 grand. Am I right?

But (yes, there’s always a but), you can’t simply empty your savings account and pour it all into the market… not without taking the time to really understand how investing works. Sure, we all want to sign up for an 8% return, but remember, that 8% is not guaranteed. If you make the wrong investing choices, you could see far smaller returns, or even losses. So keep reading the Money Minute for tips on how to invest the right way, but if you’re gung-ho to get investing right this second, check out my article Index Funds and Chill for tips.

I also want to highlight a golden rule that I think is really underemphasized in financial literacy: unless you’re making dividends from a stock, you do not make a profit on your investments until you sell your shares. Let’s rewind that last example: if you get 8% gains on your $10,000 investment, you can’t really consider that money in your pocket.

You need to always remember that your bank account and your brokerage account are two very different entities. The money in your brokerage account is only yours to spend once you cash-out on an investment.

If you own a stock price that has doubled in value, you still haven’t made any money on it yet. This is a very common misconception that drives me absolutely nuts. Someone will tell me that if they bought a stock for $5 and now it’s $10, that their profit is double their investment. No! That is wrong. You can only “profit” on an investment when you sell the investment. Again, your brokerage account is not the same thing as your bank account. You can’t buy groceries with slivers of your Index Funds.

xo,

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