When you're saving for the future, it's easy to get caught up thinking about how much you need to save, how much time you have to save, or how to save more. But one of the most critical factors people often overlook is where to save.
Stashing your money in the wrong places could put your financial future at risk. And if you're putting your retirement savings in a savings account, that could be doing more harm than good.
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Why to avoid savings accounts
Savings accounts aren't all bad -- especially if you're using a high-yield savings account. But they're best for short-term financial goals (such as building an emergency fund), not long-term targets (like saving for retirement).
That's because even the best savings accounts only earn between 1% to 2% per year in interest. Meanwhile, the average inflation rate over the last few decades has hovered around 2.5% per year. If you're preparing for retirement and expect to keep your money in a savings account for decades, those savings won't even keep up with inflation. In other words, your money will be worth less in retirement than it is now.
In addition, savings accounts make it much harder to save a substantial amount. Say, for instance, you're saving $500 per month in a savings account earning 1% per year in interest. At that rate, you'll have around $209,000 saved after 30 years. While that's a good chunk of change, if you had been investing that money and earning an 8% annual return, you'd have close to $680,000 in the same time period.
Limiting your risk while investing
It's understandable why many people may choose savings accounts over investing in the stock market. Investing can be risky, and nobody wants to lose their hard-earned money -- especially when your retirement is on the line.
However, investing isn't as risky as it may seem. And if you're investing in the right places, you can limit your risk while giving your savings a serious boost.
One of the best ways to get started investing is to contribute to your 401(k) or IRA. When you invest in your retirement account, you're typically investing in mutual funds. These are large collections of stocks and bonds, and each mutual fund may contain hundreds of different stocks -- which limits your risk substantially.
Many 401(k)s and IRAs also give you the option of investing in target-date funds. With a target-date fund, you provide the year that you plan to retire, and the fund takes care of the rest. It will automatically allocate your investments depending on your age, investing more aggressively when you're younger and then gradually becoming more conservative as you get closer to retirement.
What about market crashes?
Stock market crashes, unfortunately, come with the territory when investing. The good news, though, is that market crashes are only temporary. And as long as you're investing in the right places, your savings will stay safe over the long run.
The stock market has experienced countless downturns over the years. But regardless of how severe the crashes have been, the market has recovered each and every time.
The key to surviving a stock market crash is to invest for the long term. Even the safest investments may take a tumble in the short term, but they'll bounce back eventually. If you're investing primarily in mutual funds through your 401(k) or IRA, those investments are very likely to recover if given enough time. So if the market crashes, don't panic. By waiting it out, you'll reap the rewards later.
If you're starting to save for retirement, you're already taking a step in the right direction. By investing your money, though, you can supercharge your savings and create a more secure financial future.
