In its simplest terms, if you want to buy something in the near future, open a savings account. If you have some extra cash laying around (that you don’t plan to use for several years) AND you’re not afraid of it losing value in the short term (approximately 5 years), consider investing in the stock market. Putting your money in a savings account will keep it safe but it will only grow at a fraction of what the stock market has averaged over the last several decades. Consider the following scenarios:
- Standard & Poors 500 (S&P) performance vs. Savings account performance for the 25-year period from 1988-2013;
- S&P performance vs. Savings account performance for the 13-year period from 2000-2013 (Entering the stock market right before a major recession)
Both S&P scenarios assume dividends from dividend-paying stocks are invested back into your portfolio. Market value excludes inflation, taxes and/or investment costs. Calculator based on the S&P Composite Stock Price Index compiled by Yale economist Robert Shiller. Additionally, both savings account scenarios assume a very generous 4% annual interest rate. The best you’ll find today is around 1.25%.
Scenario 1 – the 25-year period between 1988 and 2013
In this scenario, $1000 invested in the stock market in an investment that was tied to the S&P would be worth 12 times more after 25 years. The same amount kept in a savings account would have grown only just over 3 times. And, this is assuming a very generous 4% interest rate paid on your savings account! Even after the recession of 2001 and 2008, you would have been way ahead compared to returns from a savings account. As a matter of fact, your $1000 investment in any time period in the S&P 500 after 1988 and kept until 2013 yielded more than having your money in a savings account. The only exceptions would have been had you started in 2000 and kept your money invested in the stock market until 2013.
Scenario 2 – the 13-year period from 2000-2013 (right before the recession of 2001!)
If you had impeccably BAD timing of putting $1000 in the stock market in 2000, then you would have gone through some jitters. You suffered two economic downturns, 2001 and 2008. Your money lost 35% of its value by 2002, to $656. On the other hand, that same $1000 grew to $1103 in a savings account. Nonetheless, at the end of the 13-year period, your money in both the stock market and in a savings account performed about the same and had grown by approximately 66%, to $1662.
You cannot lose money in a savings account; the federal government, through the Federal Deposit Insurance Corporation, or FDIC, insures their value, up to a limit. When you invest money, however, you automatically assume a level of risk. Generally, your goal is to achieve a relatively high rate of return, but you must balance the desire to make money with your tolerance for losing it. Most investors, particularly those with quite a few years left before retirement, use stocks, in some form, as a large part of their investment strategy.