When planning how you want to manage your finances, one question you’ll likely ask yourself is whether you should focus on growing your savings or using your cash to invest. So often we are warned of the low returns on savings, but at the same time we are reminded that the value of our investments could go up as well as down. With what seems to be conflicting information, it can be difficult to decide which option you should be prioritizing.
Understand that you don’t necessarily have to make a choice between one or the other.
Each has its role to play in your financial picture and having a combination of both cash in savings and in investments can certainly work to your benefit. Once you understand the role each plays, you can be more confident in the decisions that you are making and what you prioritize.
First and foremost, when thinking about how to allocate your cash, ask yourself, do you have money outstanding on your credit cards or other high interest loans, or are you often finding yourself overdrawn? If the answer is yes to any of these questions, your priority should be ideally focused on paying down that debt and building up some cash savings. It's not necessarily smart to focus on investing if your high interest debt is ultimately costing you more than the returns you are likely to gain from investing.
Cash for the short term
If you’ve assessed your debt situation and you do have cash available to either save or invest, start thinking about the role each option plays in your financial plans. Cash is a great source of meeting emergency and short-term needs, so if your car were to break down, or you have plans for a vacation in the coming months, having easy access to cash to pay for these things certainly makes sense. Furthermore, after the financial uncertainty we all experienced during the COVID lockdown, having access to cash in savings which can sustain you over a period of time is certainly a priority that we should all be planning for.
To create that cash buffer for shorter term needs and emergencies, consider opening a high interest savings account. By choosing an online savings account you can open it in a matter of minutes on your phone or at your desk. While the current interest rates on savings accounts aren’t going to make you a millionaire overnight, earning 0.50% interest on your cash in an online savings account versus 0.01% holding cash in a standard checking account does make sense. Particularly when its cash that you don’t need immediate access to.
It's not smart to focus on investing if your high interest debt is ultimately costing you more than the returns you are likely to gain from investing.
Invest for the longer term
As an investor, your aim is to make money by investing in companies, or groups of companies that you believe will do well for the long term. Investing provides you with a great form of passive income, which can be significant if the companies or funds you choose to invest in continue to turn a profit.
Not only will you benefit from watching your initial cash investment grow over time, but you will also earn from the interest on your investments being reinvested and earning more interest on top of that - with no effort on your part – this is what’s known as compounding interest.
1) Interest + 2) Reinvested = 3) Earning more interest on top
Not enough of an incentive? Well, if the companies or funds that you invest in pay dividends, you will also earn money on your investments every time the company or fund rewards its investors by paying out a dividend. A dividend is a percentage on the dollar which a company pays out to its investors when the company is profitable. It is like a “thank you” by the company to its investors and often companies will pay out dividends either on a quarterly or annual basis. So, for being a loyal investor, as long as you hold the stock you can earn dividends without having to do anything more.
Of, course, your ability to earn through your investments will depend on the success of the companies you invest in, so don’t forget that the value of investments can fluctuate, which means that their value can go up, but they and also go down. If the companies do well, your initial investment will grow, but you can also make a loss if the investments perform poorly over time.
Taking a longer-term view with your investments can be a great way of putting your money to work for you. The power is in your hands to choose what you invest in and from that point on, if you remain invested and the stocks are growing, the mechanics of the market will automatically earn you money with little further effort on your part.
Final thought...
Consider how easily you wish to be able to access your cash either in a savings or an investment account. You’ll likely find that savings accounts which require a notice period to take out your cash will pay a more attractive interest rate, but an instant access savings account will allow you to take out your cash as and when you need it. Investing through a brokerage account means you can also access your funds as and when you need to, however in order to sell a stock there needs to be a buyer on the other side, so your ability to sell out and access your cash will depend on how liquid the market is. A liquid market simply refers to how much buying and selling activity there is in the market and therefore how easy it is for you to sell out of your stock position. For the majority of us, we will be invested in commonly traded stock which can be easily bought and sold in minutes, so accessing your invested funds when you need to should be possible same day.
Now armed with this information, you are better prepared to determine how you want to allocate your cash so that it works best for you. As you have read, you don’t have to feel compelled to choose one option or the other. Your long term and short-term plans can comfortably co-exist, with both savings and investments putting you in a great position to get the most value out of your cash.
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