Make Sense of Saving/Investing with These Five Questions

Saving and investing are both important components of a solid financial foundation. They also have unique characteristics that dictate when each one makes the most sense.

The level of risk vs. return is the most significant difference between the two. Savings will generally result in a lower return (via earned interest), but it will do so with virtually no risk. Investing, on the other hand, can yield significantly higher returns, but it also comes with a greater risk of loss.

Since the S&P 500 index started tracking in 1957, the average annual returns on stocks have averaged roughly 10%. Compare that with high-yield savings accounts, which typically earn less than 2%. Although stocks are far more volatile in terms of price fluctuations (you may have noticed that this year), this opportunity for higher returns makes them a valuable weapon in your financial arsenal. But it's important to know when to use them.

Here are five questions to ask to help find the appropriate amount of risk and return for you.

Question 1: Do you have any consumer debt?

If so, you’re certainly not alone. But not all types of debt have the same impact on your finances. A mortgage, for instance, is helping you build equity. But high-interest credit card debt will continually hold you back. By paying it off first, you can save hundreds if not thousands of dollars in interest that you can then put toward your other financial priorities.

Question 2: Do you have an adequate emergency fund?

Before deciding whether to save or invest your money, consider how much cash you have to fall back on in an emergency. What qualifies as "enough" will vary based on several factors, like your income and job security. The right amount will depend on the individual and their level of risk tolerance. But these are some popular guidelines:

• While you’re working, make sure you have 6-12 months of living expenses set aside.
• Once you retire, have the equivalent of 1-3 years of the income you plan to earn from investments.

Question 3: How best to save?

Since they're not subject to market fluctuations (and are typically FDIC-insured), high-yield savings accounts are a good option for both your emergency fund and your short-term savings. They're also helpful as you're trying to save up for certain financial milestones. Saving in this way is a good choice for many short-term needs – those with a 1-3 year timeframe, like a home or vehicle purchase.

Choosing a straightforward online savings account like those offered by CapitalOne and American Express will allow you to earn some interest with no risk attached. They also typically allow quick access to your cash, no fees, and easy mobile access.

Question 4: Do you want more cash on hand?

In addition to savings accounts, when you want more cash (or cash equivalents) on hand, another option to consider is U.S. Treasury securities. This would include treasury bills, treasury notes, and Series I savings bonds. 

Treasury bills (a time frame of one year or less) and Treasury notes (2-10 years) have all yielded in the 3% range in recent months, as interest rates have risen.

Series I savings bonds have become popular in in 2022 because of the higher yield (9.62% through October 2022) due to higher rates of inflation. There are some restrictions, however, such as a one-year lock up period, and are generally limited to $10,000 per person per year.

Question 5: When to invest?

If you’re looking to invest beyond the 1-3 year timeframe – and you've paid off your high-interest debt and secured your emergency fund – consider investing in stocks, whether in the form of individual stocks or funds. Even given occasional contractions, the market has historically risen over the long run.

For less risk, consider higher dividend yield stocks. For more risk (and hopefully higher returns), consider "growth" stocks – those that tend to increase in capital value more than providing income. If you want to invest but balk at the prospect of choosing and purchasing stocks, consider a mutual fund or ETF (exchange traded fund). In these funds, since a pool of investors contribute toward a stock purchase, you assume indirect ownership and professional money managers make the investment decisions for you.

The important thing is to get started.

When dealing with the market, there are no perfect rules, and there are no guarantees. Yes, investing can present some confusing options. But there are still easy ways to get started. If you’d like to learn more about ways you can ensure your money is working as hard – and smart – as possible, reach out to one of our professional advisers today.

Hunter Yarbrough, CPA, CFP, is an executive vice president and financial adviser with CapWealth. He is passionate about taking a holistic view of personal finance, including investments, taxes, retirement, education, estate planning, and insurance. For more information about Hunter and CapWealth, visit capwealthgroup.com.