The Right Way to Save Money According to Your Risk Tolerance
Outside of winning the lottery (the chances of which the official Powerball website puts at about 1 in 175 million), the best way to ensure future financial stability is to start saving as soon as possible. If you really want your money to grow, you need to think seriously about where you put it.
According to Andy Tilp, a certified financial planner at Trillium Valley Financial Planning in Sherwood, Ore., this is not the time to “live in fear and hide your money under the mattress.”
There are many options for where and how to save money for the future, including a basic savings account, which is relatively low-risk, but offers only small returns on your investment.
Tilp says putting the money in a savings account is parking your money in a safe place that is guaranteed not to lose money (as long as it is an FDIC-insured bank or NCUA-insured credit union). But it also gives permission to the saving institution to use your money to make loans and other investments so the bank can increase its profits.
“The bank returns some of this to you in the form of a small amount of interest. But, because they are taking the risk, then they will make a greater return.”
Certificates of deposit (CDs) and money market accounts are higher-risk than basic savings, but still won’t deliver the big payouts of a long-term investment in the stock market. Tilp says that these investments are best for more immediate savings that you plan to use three to five years in the future.
When investing money for long-term goals—for example, if you want to be financially independent by the time you retire—stocks, bonds and mutual funds offer the potential to earn your money higher rates of return.
By giving your money the opportunity to grow over time, you also take on the risks that there will be some dips and losses along the way.
“With stocks and bonds, you are having the money work for you, whereas with a money market, CD or savings account, you are letting someone else use your money to work for them,” Tilp says. There is more risk in stocks and bonds, but there is also greater potential reward.
“Be a frugal investor and look for inexpensive ways to invest,” Tilp says. “Diversify. Be patient and resolute. Don’t bail at the first hint of a loss.”
Tilp adds, “You don’t want to look back 20 years from now and say, ‘I wish I would have saved and invested more.’”
“Diversification” means not putting all your investment eggs in one basket. You can do this by selecting a variety of securities—such as a mix of stocks, bonds, cash and real estate; a variety of funds within one asset class (e.g., stocks from large, medium and small companies; international and domestic companies; and various industries) and a variety of maturity dates for fixed-income investments (bonds).
[Any reference to a specific company, commercial product, process or service does not constitute or imply an endorsement or recommendation by the National Endowment for Financial Education.]