Saving money is great, but it’s not going to make you wealthy.
Putting money aside and letting it sit idle means that when you come back to that money, it will be exactly the amount you saved. If you saved $10,000 a year for 5 years, you’d have $50,000, but if you invested that same amount (assuming an 8% return), you would have $63,359.29. Just by simply investing your money, you increased your net worth by more than $13,000, and that’s just over five years.
The habit of savings is great, but it’s what you do with the money you save that will make you wealthy. Wealth comes from taking the money you have, putting it to work, and allowing it to compound.
Now let’s outline what to do with your savings to build long-term wealth.
First, Let’s Separate the Action of Saving from Savings as an Entity
When people talk about savings, it’s often tough to differentiate savings as an action from savings as a thing. The action of savings involves setting aside a portion of your income for future needs, whereas the savings as an entity represents an account where you’re holding cash.
Savings as an action is fantastic. The ability to defer gratification is one of the most important skills for long-term wealth. By building a habit of living well within your means, you will have money that you can grow. And the more you can save, the more your foundation for growth. If you haven’t already, start tracking your spending, and build a budget so you can start being intentional with the money you put aside.
Savings as an entity on the other hand serves a purpose, but is not necessarily something you want a lot of. Having access to cash when you need it is important, and keeping an emergency fund for this purpose is a great way to do this. On the other hand, by letting your money sit idle, you’re essentially losing value. Every year, inflation decreases the value of your money by around 2%. So by having money sit in a savings account that returns ~0.25% interest, you’re essentially reducing the value of your money by 1.75% each year. Keeping some ready-access cash is great, but by keeping a large amount of your net worth in cash you’re losing money.
Savings as a habit is the foundation of what’s to come next. In order to have money to put to work, you need excess money. Having money in a savings account can be beneficial, but only for specific circumstances.
What to do with Your Savings – Factors To Consider
When considering where to put your money, there’s two primary things to consider: Liquidity and Risk
Liquidity represents how quickly you can convert an asset into cash. Having liquidity means that if an urgent need comes up (an emergency, an opportunity, etc.), you can quickly get cash to pay for whatever you need. This can enable you to quickly pounce on opportunities or handle emergencies without taking on expensive loans. At the high-end of liquidity is cash, either in physical bills, or money in a chequing/savings account. This money is already in the form you need to pay for things, so you can use it immediately. On the low-end of liquidity is an asset like real estate. You may have a house with hundreds of thousands of dollars worth of equity, but to convert that to cash is no easy task. It takes engaging a realtor, listing the home, and then closing the sale. Not something that happens quickly.
Risk on the other hand represents the ability for the asset you purchase to fluctuate in value. With riskier assets, there may be more fluctuation in the value. This could result in the value being low when you need to convert it to cash. Stocks are an example of a more high-risk asset. The stock market fluctuates daily, and swings of >30% in a year are not uncommon. An example of a low-risk asset would be cash in a savings account. There may be some reduction in the value of the money with inflation, but there’s no question as to how much will be there when you need it.
It’s important to consider when you will need the money to be able to assess your individual volatility and risk criteria.
What to Do With Your Savings
When choosing what to do with your savings, you need to think about what you are saving for.
There are some things big expenditures that could be coming in your near future, like purchasing a house or paying for a wedding. Or there are longer-term savings for things like retirement, your childrens education, etc. It’s important that you pair your investment choices with the needs – you never want to invest money that you can’t afford to lose (especially in the short-term).
With that in mind, let’s explore some options in various time frames to see what resonates with you.
Before Anything Else, Get an Emergency Fund Set-Up
Now I know I said above that you don’t want to hold a lot of money in cash, but an emergency fund is a key exception and is crucial for financial security.
An emergency fund is your first line of defense if anything goes south. You should hold 3-6 months worth of living expenses in cash in case you lose your job, get hit with an unexpected bill, or anything else that this life could bring. Having this cash at the ready means that you don’t need to liquidate assets or go into debt to pay your bills, which are actions that could take years to come back from.
So with your defenses in place, let’s explore where to go from here.
What to Do With Savings You’ll Need in 1-2 Years
When you need capital in the short-term, you don’t have time to recover if an asset drops in value. As such, risk is typically low and liquidity is high.
High-Interest Savings Accounts
High-interest savings accounts provide great liquidity and basically no risk – you know exactly how the money will grow. That said, the returns aren’t typically too high (a couple percent). These are great when you know you’ll need the money soon, or while you are preparing for a different investment (e.g. storing money for a down-payment here as you find the right home).
GICs
GICs are a canadian investment that allows you to deposit money for a specified time frame with a guaranteed return. These are a great low-risk option when you know when you’ll need the money at a specific time (e.g. tuition), but the money is locked up until the GIC matures. These typically provide better returns than high interest savings accounts.
These options can be extended over long time periods, but the returns will not be near as good as what’s to come.
What to Do With Savings You’ll Need in 3-10+ Years
When you’re thinking in longer time frames, you have enough time to weather some market crashes and come out ahead.
Stocks and Bonds
Investing in the stock market is a fantastic way to build wealth. Now there are a ton of strategies with the stock market with varying time frames, but when thinking in the 3-10 year range I’m specifically talking about the performance of the whole market (index funds). Though the stock market can be considered higher risk, the S&P 500 has averaged around 10% annual returns. And when you’re investing for longer time frames, you have time to recover from stock market crashes (e.g. 2008). The stock market is also quite liquid (depending on what you’re investing in), though it may take some effort to move money out of a brokerage account.
The stock market is great for growing money in the mid-term, and with compounding, it will only get better with more time.
If you’re in Canada, check out Where to Allocate Investments.
What to Do With Savings You’ll Need in 10-20+ Years
When you’re looking at the long-term, you can invest in long-term plays when considering what to do with your savings. These assets won’t make you a quick return, but can create immense wealth in the long-run.
Real Estate
Many millionaires tout that real estate is key to building wealth, and it’s not surprising.
If done well, investing in real estate can increase your net-worth through appreciation, mortage pay-down, and cash-flow. It’s key to call out here that I’m speaking to investment real estate, and not necessarily your primary residence. As per Rich Dad Poor Dad, your primary residence is actually a liability (if you haven’t read it, this book will open your eyes).
Investment real estate is not a short term play though. It takes time and effort to buy the right properties, make any necessary improvements, and start making money off them. That said, the longer you hold a property, the more time for appreciation, mortgage pay-down, and rents typically go up – increasing the cash flow. Real estate is not a liquid asset though, so you need be willing to invest the money for the long-term.
Real estate can be a great path to wealth, but it takes more time and effort than other strategies.
Private Businesses
Investing in private business is a high-risk high-reward way to build wealth. But when it pays off, it can pay off big.
According to the U.S. Bureau of Labor Statistics, 20% of new businesses fail in the first 2 years, 45% in the first 5, and only 25% make it to 15 years or more. That said, getting in on the ground floor of a business, whether starting your own or investing in someone elses, can be incredibly fruitful – think about the early investors of a company like Facebook. Picking the right business is challenging, and this investment will probably take a long time to really pay off.
Investing in private business should be done wisely, with a recognition of the risk levels involved.
Summary – What to do with your savings
When considering what to do with your savings, you should consider both when you need your money out, and your tolerance for risk and liquidity. Here’s the suggested assets for different time frames:
- 1-2 Years – Stick to safe, low-risk ways of getting some return, like high-interest savings accounts or GICs. This will put your money to work while also ensuring it’s there when you need it.
- 3-10+ Years – When looking at longer time frames, you can introduce more risk. The stock market has a good track record of returns over this time period. And if this is a strategy you like, you can extend it over longer time period as well.
- 10-20+ Years – At this time frame, you can explore long term plays like investing in private business, or long-term wealth building like real estate. These won’t pay off immediately, but can bring great returns when held over the long-term.
So now you know what to do with your savings, figure out when you need the money, and put it to work for your long-term wealth.