Choosing between investing your money and putting it in a high-yield savings account is a common decision when you’re looking to grow your wealth. High-yield savings accounts, which are typically offered by banks, are a secure place to park your money, offering a higher interest rate than a regular savings account. On the other hand, investing involves purchasing assets like stocks, bonds or real estate with the expectation of generating returns over the long term. Investments carry higher potential returns but also higher risk, as their value can fluctuate. A financial advisor can help you assess your options and find a strategy for achieving your financial goals.
What Is a High-Yield Savings Account?
Simply put, a high-yield savings account is a bank account that provides a higher interest rate when compared with traditional savings accounts.
The concept of “high-yield” focuses on greater returns that are based on higher interest rates. According to the Federal Deposit Insurance Corporation (FDIC), the average percentage yield (APY) of savings accounts ranged between 0.07% and 0.45% between April 2021 and September 2023. The APYs offered by the largest banks are often significantly lower than that – even as low as 0.01%.
High-yield savings accounts, on the other hand, have APYs that have skyrocketed on the heels of a series of Federal Reserve interest rate hikes that began in early 2022. By October 2023, APYs of 5% or 6% were not uncommon. Imagine you deposit $10,000 in a high-yield savings account with a 5% APY. By the end of the first year, you would have pocketed $500 in interest compared to just $45 had you put your money in an average savings account.
Basics of Investing
Investing refers to buying assets in the hope that they will generate income or increase in value over time. Think of investing as harnessing the power of your money to work for you.
There is a wide range of assets to invest in —stocks, bonds and mutual funds to name a few. Stocks offer you a slice of a company and an entitlement to a portion of the company’s earnings and assets. Bonds, alternatively, are akin to lending money to a corporation or government, where you play the lender and earn interest over time. A mutual fund is a communal pool of money from multiple investors that’s funneled into a diversified portfolio of assets.
One fundamental concept in investing is risk and reward. Generally, the higher the potential return, the greater the associated risk. Stocks, for example, offer the potential for significant gains but also carry higher risk due to market volatility. Conversely, bonds are generally considered less risky but offer lower potential returns.
Pros and Cons of High-Yield Savings Accounts
High-yield savings accounts tick plenty of beneficial boxes – they’re relatively low risk, offer a predictable return in the form of interest and grant easy access to your funds. While they’re ideal for emergency funds or short-term savings goals, there are also potential drawbacks to consider, as well.
Pros of High-Yield Savings Accounts
- Higher interest rates: One of the primary benefits of these accounts is the opportunity to earn significantly higher interest rates compared to traditional savings accounts. This means your money can grow faster.
- Safety: High-yield savings accounts are typically offered by well-established banks and credit unions, which means your deposits are usually insured up to a certain limit ($250,000) by the FDIC or National Credit Union Administration (NCUA). This provides a level of security for your savings.
- Liquidity: These accounts offer easy access to your funds, often allowing you to make withdrawals or transfers online or through ATMs.
- No risk: Unlike investments in stocks or bonds, high-yield savings accounts are virtually risk-free. Your principal amount remains intact, and you earn interest on top of it.
Cons of High-Yield Savings Accounts
- Lower returns compared to investments: While the interest rates are higher than regular savings accounts, they are still generally lower than potential returns from investing in the stock market or other higher-risk assets.
- Inflation erosion: In periods of high inflation, the interest earned on these accounts may not keep pace with the rising cost of living, potentially reducing your real returns.
- Limited transactions: High-yield savings accounts often have limitations on the number of monthly transactions or withdrawals you can make, which can be inconvenient for some.
- Interest rates change: High-yield savings account interest rates can fluctuate with market conditions and the policies of the financial institution. This means your returns can vary and may not always be as high as expected.
Pros and Cons of Investing
Investing can be a roller-coaster ride of highs and lows. Over the long term, it generally offers higher returns than high-yield savings accounts and the added benefit of diversification, helping balance out risk. While the returns can be higher, market turbulence can lead to potential losses in the short term.
Pros of Investing
- Potential for wealth growth: Over time, your investments can benefit from the power of compound interest, where your earnings generate more earnings, outpacing inflation and accelerating your wealth accumulation.
- Passive income: Certain investments, like dividend-paying stocks or real estate, can provide a steady stream of passive income, increasing your financial security.
- Diversification: By spreading your investments across different asset classes, you can reduce risk. Diversification can help protect your portfolio from the volatility of individual investments.
- Tax benefits: Some investments offer tax advantages, such as tax-deferred growth in 401(k)s or IRAs, as well as preferential tax rates for long-term investments.
Cons of Investing
- Risk of loss: All investments carry some level of risk. Markets can be unpredictable, and you may lose some or all of your initial investment.
- Time and knowledge: Successful investing requires time for research and monitoring. Without proper knowledge, you may make poor investment choices.
- Liquidity constraints: Some investments, like real estate or certain retirement accounts, may have restrictions on when you can access your money.
- Emotional stress: Market fluctuations can be emotionally challenging. Fear and anxiety can lead to impulsive decisions that harm your portfolio.
How to Choose Between High-Yield Savings and Investing
To make an informed decision when weighing high-yield savings vs. investing, consider three key factors: your emergency fund, your time horizon and your risk tolerance.
Do You Have an Emergency Fund?
An emergency fund is an essential financial building block. This is your financial safety net for unforeseen stresses such as medical emergencies or job loss. Without this safety net, your investments might be at risk, potentially suffering penalties or losses if the market is underperforming. As a result, experts recommend building an emergency fund with between three and six months’ worth of living expenses before investing in riskier assets.
What’s Your Time Horizon?
Consider your financial goals in relation to time. If you’re saving for a short-term goal, like a down payment for a house in two years, a high-yield savings account may be the most appropriate place for your money. Conversely, for long-term aspirations, like retirement or saving for a child’s college education, it could be beneficial to ride the investment wave.
What’s Your Appetite for Risk?
Risk tolerance or how comfortable you are with witnessing your money fluctuate, is key. Risk tolerance and time horizon often go hand-in-hand. If risk knocks you off balance emotionally or you simply can’t afford to suffer any losses, a high-yield savings account may be better suited for your situation. However, if you can weather the emotional ups and downs of market fluctuations, investing can lead to higher returns.
There is no magic formula for choosing between a high-yield savings account and investing – both have their unique strengths and drawbacks. Your choice should be guided by your personal financial situation, goals and risk tolerance.
- Finding the right mix of stocks, bonds and cash for your risk tolerance and time horizon can give you peace of mind when investing. SmartAsset’s asset allocation calculator can help you identify a mix of assets that’s potentially suitable for your situation.
- A financial advisor can help you set goals and invest your money in assets to hopefully achieve them. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you canhave a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
Photo credit: ©iStock.com/ferrantraite, ©iStock.com/ChayTee, ©iStock.com/andresr
As an experienced financial expert deeply immersed in the realm of personal finance, investment strategies, and wealth management, I bring forth a wealth of knowledge to guide you through the decision-making process between high-yield savings accounts and investments. Over the years, I've witnessed the ebb and flow of financial markets, navigated through economic uncertainties, and observed the impact of various investment choices on individuals' financial well-being.
Let's delve into the core concepts covered in the article:
High-Yield Savings Accounts: A high-yield savings account is a financial instrument that has gained prominence due to its ability to provide a higher interest rate compared to traditional savings accounts. The concept of "high-yield" revolves around the notion of earning greater returns through higher interest rates. The Federal Deposit Insurance Corporation (FDIC) reports on the average percentage yield (APY) for savings accounts, indicating that high-yield savings accounts can offer APYs as high as 5% or 6%.
Pros of High-Yield Savings Accounts:
- Higher interest rates: High-yield accounts offer significantly higher interest rates compared to traditional savings accounts.
- Safety: Typically offered by well-established banks, these accounts are secured up to a certain limit by the FDIC or National Credit Union Administration (NCUA).
- Liquidity: They provide easy access to funds with online or ATM transactions.
- No risk: Unlike investments, high-yield savings accounts are virtually risk-free.
Cons of High-Yield Savings Accounts:
- Lower returns: Although higher than regular savings, the returns are generally lower than potential gains from investments.
- Inflation erosion: In periods of high inflation, the interest earned may not keep pace with the rising cost of living.
- Limited transactions: There are often restrictions on the number of monthly transactions or withdrawals.
Investing: Investing involves purchasing assets such as stocks, bonds, or real estate with the expectation of generating returns over the long term. The fundamental concept in investing is the trade-off between risk and reward. Different assets carry varying levels of risk, with stocks offering higher potential returns but also higher volatility, while bonds are considered less risky but offer lower returns.
Pros of Investing:
- Potential for wealth growth: Investments can benefit from compound interest, outpacing inflation and accelerating wealth accumulation.
- Passive income: Certain investments, like dividend-paying stocks or real estate, can provide a steady stream of passive income.
- Diversification: Spreading investments across different asset classes helps reduce overall risk.
- Tax benefits: Some investments offer tax advantages, such as tax-deferred growth in retirement accounts.
Cons of Investing:
- Risk of loss: All investments carry some level of risk, and markets can be unpredictable.
- Time and knowledge: Successful investing requires time for research and monitoring.
- Liquidity constraints: Certain investments may have restrictions on accessing funds.
- Emotional stress: Market fluctuations can be emotionally challenging, leading to impulsive decisions.
Choosing Between High-Yield Savings and Investing: To make an informed decision, consider three key factors: the presence of an emergency fund, your time horizon, and your risk tolerance. An emergency fund is crucial before venturing into riskier assets, and your time horizon and risk tolerance determine whether a high-yield savings account or investing is more suitable.
In conclusion, the choice between high-yield savings and investing hinges on individual financial situations, goals, and risk tolerance. There is no one-size-fits-all approach, and seeking guidance from a financial advisor can play a pivotal role in aligning your choices with your unique circumstances. Whether opting for the security of a high-yield savings account or the potential returns of investments, a well-informed decision can pave the way for financial success.