For my whole life, I’ve never had much savings. Although I had part-time jobs, all my money went to paying my university tuition or living expenses.
In September 2019, when I started my full-time job, for the first time, I actually had some extra money in my bank account. This was great, but I wasn’t sure whether I should put this extra money in a high-interest savings account or in investments, and if so how much??
If you have the same questions as I did, in this article you will learn how to effectively use a Savings Account and whether you should keep your money in a savings account or in investments,
How to Use A SAVINGS ACCOUNT
Now I’m sure you’ve always heard about “High-Interest Savings Account” from your local bank but how does it actually work? These accounts have two main qualities: HIGHLY LIQUID, and LOW-INTEREST BEARING.
1. HIGH LIQUIDITY
These accounts are similar to your chequing accounts as it is an account to store your money so that it is easily accessible. The money in your savings account is HIGHLY LIQUID, which means you can easily convert the money to buy goods/services. This is really important because sometimes you suddenly need some money on hand.
Let’s say your car breaks down, and you need $5,000 immediately for repairs. If you don’t have enough liquid money, you won’t be able to pay for your car repairs.
This is what makes the savings account perfect for your EMERGENCY FUND. Your emergency fund should be around $5,000 – $10,000 (depending on your circumstances) and should be liquid money on-hand.
2. LOW-INTEREST BEARING:
The major difference from your chequing account, is that the money in your savings account generates a low-interest return, usually around 2-3%. This interest is quite low, but it’s better than the 0% interest on your chequing accounts. (If you have $10,000 in your savings account that’s an extra $300 per year! You can buy a lot of things with $300 D:).
Another interesting perspective is if you take inflation into consideration. Inflation is the increase in the price of goods and services (clothing/food/haircuts, etc). Every year, goods and services increase proportionally by the inflation rate which is approximately 2-3%. See the chart below for a 10 year record of the inflation rate in Canada. Another benefit of the savings account is that it ensures that your money is at growing at the same rate of inflation and not decreasing in value.
Pros
- High Liquidity
- Protects the value of money from inflation
- Perfect to hold your emergency fund money
Cons
- Low Interest rate (2/3%) compared to investing
INVESTMENTS
If you’ve read my other articles, you already know the basics of investing. For a quick re-cap investing is when you buy shares/bonds in other corporations.
Keeping your money in investments has the opposite qualities of keeping your money in a savings account:
1. LOW LIQUIDITY
Remember high liquidity means that you can easily convert your money to buy goods/services, therefore low liquidity means that it is difficult to convert your investments into CASH.
When you first buy a share/bond, you trade your cash to receive ownership of the share/bond. Your share/bond may have the same or even more value than your money, but if you can’t use it to buy normal goods/services.
If your car breaks down and you need $5,000, you’re not going to ask your mechanic if you can give your $5,000 stock in-exchange for car repairs. You would first have to SELL your stock, convert it into cash, then pay for the car repairs.
This is why you should first focus on having an emergency fund, before putting your savings into investments.
2. HIGH-INTEREST BEARING:
In comparison to the low-interest returns on savings account of 2-3%, the average return on investments over the long-term is 7%. This is based on the assumption that 100% of your money is invested in the stock market and over the long-term which is 10+ years). WARNING: The stock market often goes up and down and value, which can make investing risky if you need your money in the short-term (1 – 5 years).
For a more detailed explanation on how the stock market works, read: “Should I Invest My Money?“
Pros
- Higher interest rate (average of 7% in the long-term)
- Perfect to hold your savings for medium/long-term financial goals (3+ years)
Cons
- Low Liquidity
- Volatile Market (Not guaranteed a 7% return)
SUMMARY
Overall, there are pros and cons to having your money in a savings account or investments. Personally, I would first focus on storing my emergency fund of $5,000-$10,000 in a high-interest savings account that generates a 2-3% return. This ensures my money is not decreasing in value due to inflation. Next, I would start to put any additional savings into ETFs to generate a higher return for my Medium to Long-term (3+ years) financial goals.
