Saving money for retirement savings is a challenge, but it’s only half the battle. You also need to decide where you are going to house this money so that it can grow over time without putting you at too much risk. The right choice largely depends on the types of accounts you have access to and your long-term goals.
But there’s one place where you should never keep most of your retirement savings, at least if you’re hoping to retire anytime soon.
How much do you earn on your savings?
Personal retirement savings can be broken down into two parts: your contributions and your income.
- Contributions are the dollars you earn and set aside for retirement each year.
- Earnings are the extra money you get from where you keep your money.
Save in a savings account: If you put your money in a savings account, your income is based on your account balance and your annual percentage return (APY). The current average APY savings account is 0.06%. This means that for every $ 10,000 you have in your account, you will earn $ 6 per year.
Save by investing: When you invest, your earnings depend on the return on your investments. Investing in bonds could earn around 5% to 6% per year. Investing in stocks could potentially give you a 30% return in a great year, but you could also lose that much in a bad year.
Your returns are also not guaranteed until you sell your stocks. Prices fluctuate over time. This can have a significant effect on the balance of your portfolio, especially for those with substantial savings.
This volatility can make investing seem like a risky proposition compared to keeping your money in a savings account where it looks like you can only win, albeit at a slower pace. But this is a false premise.
So what is riskier? Saving for retirement in a savings account or investing?
For one thing, money in a savings account is only protected up to $ 250,000 per person per bank. If you keep more than that in a savings account and your bank goes bankrupt, you could lose the surplus. While unlikely, it’s a risk you probably don’t want to take.
Keeping your money in a savings account can also be risky as the inflation rate often exceeds even the best savings account APYs (annual percentage return. This means that you will actually lose purchasing power over time. time because the growth rate of your savings is not enough to keep up with the rising cost of living.
Although there is a risk of loss in investing, there are things you can do to reduce this risk. And the potential for long-term earnings can make it much easier to save enough for retirement.
Let’s say you’re 25 and trying to save $ 1 million by age 65. If you keep that money in a savings account with an APY of 0.06%, you will need to save at least $ 2,059 each month for 40 years in order to reach your goal. And even then, you would expose yourself to the risks discussed above.
If you had invested that money instead and got an average annual rate of return of 7%, you would only have to save $ 405 per month. Over 40 years, this represents nearly $ 794,000 less in personal contributions to achieve the same goal. Imagine what you could do with $ 794,000 in your lifetime. Investing doesn’t seem so risky anymore, does it?
Balancing risk and reward when saving for retirement
The benefits of investing are undeniable, but that doesn’t erase the fact that there is risk in investing. If you choose the wrong investments, that’s a risk in itself.
For example, if you get carried away by the meme stock craze, you might end up losing your money when the stock price drops to reflect its true value or when the company goes out of business.
If you want to maximize the benefits of investing while minimizing the risk, you need to diversify your investments. It means putting your money into multiple businesses and multiple industries. This way, no business or industry can affect your portfolio too much.
An index fund is a great way for beginners to diversify their savings quickly and inexpensively. These are lots of stocks that you buy together, so you instantly get a little piece of each. Look for an index fund made up of large, established companies that you think will be there for decades to come. These stocks may not rise as quickly, but they typically generate consistent returns over time.
You should also invest some of your money in bonds, and you should spend more of it over time. This will help you avoid some of the volatility in stocks as you approach retirement age while also helping you earn a better return than you would get by leaving your money in a savings account.
Investing will never be risk free, but in the long run it’s probably less dangerous than keeping your savings out of the stock market. If you’re still unsure, start small, then try to increase your contributions over time as you get more comfortable. Also use a retirement account to take advantage of the tax benefits offered by these accounts.
And remember, when it comes to retirement savings, short-term fluctuations don’t matter. Focus on the long term. If you can, you might be surprised at how quickly you reach your retirement goal.