Savings Accounts or Stocks?
Making your money work for you is one of the most important aspects of personal finance. It can help you save for retirement, a holiday or pay for some emergency expenses.
Two ways that people try to grow their savings are through a saving account and by investing in stocks. The two strategies are very different. Each has different benefits and drawbacks, so choosing the right option is important.
What Is A Savings Account?
A savings account is a type of bank account that you can deposit money into. The money in your savings account is not immediately accessible this depends on what account you choose. Even so, you can generally withdraw small amounts immediately and larger amounts with a few days notice.
Earn interest on your deposits
- The benefit of a savings account is that the money you place in the account earns interest. Every month, the bank will give you a percentage of the money you have deposited in your savings account.
- That percentage is determined by the interest rate of the account, which is usually quoted in interest per year. So, if your savings account offers 1.00% APY and you have R1,000 in the bank, your bank will pay you roughly R10 over the course of the year.
- Banks are willing to pay interest on savings accounts because they can use the money to make loans to their other customers. By making a deposit in a savings account, you are effectively making a loan to the bank. The term of the loans requires that the bank will give the money back to you if you ask for it.
- Banks are required by law to keep a certain amount of money on hand, based on how much money customers have deposited at the bank. That means that you don’t have to worry about not being able to withdraw your cash because the bank has loaned all of it out to other people.
- Savings accounts are great for saving money that you have short-term plans for or money that you cannot afford to lose.
What Are Stocks?
Stocks are shares of ownership in a company. Shares of publicly traded companies are bought and sold on public stock exchanges. If you own stock in a business, you are a partial owner of that company. That means that you are entitled to vote on important company decisions and receive a share of the profits.
Earnings from dividends
Stocks can deliver profits to stockholders through dividends. If a company has made enough money that it does not need all of it to pay for its operation and future expansion, it will declare a dividend. Every stockholder will receive the amount of money that was declared, multiplied by the number of shares they own. So, if you own 100 shares in XYZ Company, and XYZ has declared a fifty cent dividend, you’ll receive a total of R50. You can use that money to buy more stock in XYZ company or another company or pay for other things.
Profit from rising stock prices
- Not all stocks pay dividends. This is because of the fact that some companies, especially newer, or fast growing ones, want to use all the money they take in to fund growth. Companies that don’t pay dividends can still make you money by increasing in value, raising the price of the stocks you own.
- Over time, some companies grow, and some go out of business, meaning some companies become worth more, and others less. Since owning a stock is the same as owning part of the company, if the company grows, the value of your stock will increase. You can sell your shares of the company to make a profit. If the company does poorly, the value of your stock will decrease. This is why stocks are considered volatile investments.
- You can make a lot of money if your company is hugely successful, but you can lose all of your investment if the company goes bankrupt.
Which One Yields A Higher Return?
Stocks yield a significantly higher return than savings accounts do. Since 1928, stocks have given investors a 9.5% return annually, while the highest yielding savings accounts offer that kind of earnings. Over the course of years, investing in stocks rather than savings accounts can lead to earning tens of thousands of rands more.
Consider the risk for the return
The reason for this vast difference in returns is the risk involved. The stock market can and has crashed many times before.
Diversify to reduce risk
Before you get worried about the risk of investing in stocks, it’s important to remember the effect of diversification. It is quite possible for an individual company to go out of business, and for you to lose all of the money you invested in it. It’s far less likely for a hundred companies to all go out of business together. If you purchase a wide variety of stocks, you won’t be as likely to earn huge returns on your stock, but you’re far less likely to lose it all.
Time is also an important factor, as market crashes don’t last forever. Though the stock market dropped by more than 35% in 2008, it was back to the same level by 2012, and it moved more than 50% higher by 2016. Though you can lose money in the short term, there has never been a period of time longer than fifteen years where investing in a wide variety of stocks has resulted in a loss of money. Though the past can’t guarantee the future, if you can invest for the long haul, the odds of losing money are very low.
Though you can lose money in the short term, there has never been a period of time longer than 15 years when investing in a wide variety of stocks has resulted in a loss of money. Though the past can’t guarantee the future, if you can invest for the long haul, the odds of losing money are very low.
Which One Should You Use?
In short, you should use both stocks and savings accounts. Each is uniquely suited to meet one type of financial need.
Savings accounts for the short term
- Savings accounts are designed to be used for money that you cannot afford to lose. You should also use one for short terms goals like buying a car or saving up for a down payment on a house.
- The most important use of a savings account is to keep an emergency fund. Unexpected expenses like medical bills or car repairs can pop up anytime. Having some money set aside to deal with them so you can avoid going into debt is essential to making your savings grow.
- No amount of stock or money in a savings account can outstrip the interest that you have to pay on credit card debt. An emergency fund is doubly important if you happen to lose your job since it’ll give you a way to pay the bills while you look for a new one.
- Despite the fact that you earn less money with a savings account, you can never lose the money in it. That makes it the ideal place (in addition to certificates of deposit) to store money that you’ll need in the near future or just can’t afford to lose.
Stocks for the long term
- Stocks are ideally suited for long-term goals, like saving for retirement, or building a college fund for your young children.
- The significant return you can earn from stocks will greatly accelerate you towards your savings goal. You just need the time to ride out the fluctuations of the market. If you don’t plan to retire for another thirty years, it doesn’t matter if the value of your stocks falls by 50% or more tomorrow.
- You can be confident that it will have recovered, and then some, by the time you actually need to use the money. In fact, a drop in the market in your early years of investing can be seen as a good thing. In a way, you’re buying stocks while they are on sale.
Not One Or The Other
Stocks and savings accounts are both important tools when it comes to growing your savings and making your money work for you. Savings accounts are perfect for short term savings and keeping an emergency fund of cash that you can’t afford to lose. Stocks are the best way to accumulate wealth over the long term, even if you might lose money in the short term.
To learn more about investments contact your Bank or visit one of the links below: