I gotta question for you.
When the markets went south what did you do? Did you do nothing, did you readjust your portfolio, or did move all of your money into fixed accounts? Whatever you did I hope you didn’t pick the last option.
Well, unless you’re 50 or older this would have not been a suitable option for you. In this post I will explain why you don’t want to save all of your money in fixed accounts, especially your retirement accounts.
Why Fixed Accounts Don’t Work
If your saving for an emergency fund or something like that it may be OK, but if it’s for the long term you may be making a huge financial mistake.
When I first started saving money for my later years I made this same mistake. I went to the bank started an IRA which went into a certificate of deposit account (CD) earning me a whopping 2.5%. At the time though I didn’t know any better.
To save for short term things like a car would be alright, but in the long term you need something more than that. You need the power of compounding to work for you. To do this you need two things.
- Money
- Time
These two things combined together can make a substantial difference on your financial outcome. It can mean the difference between you being poor or rich.
So if that’s the case why do lots of people save in just fixed accounts? Because it’s safe and you won’t lose any money. The risk is lower here to lose, but you still can lose in a fixed account. How? By inflation.
Inflation is the increasing cost of goods and services. Think of it this way what did a gallon of gas cost in 1970, maybe 50 cents at most and today’s it’s pushing $3 a gallon. This means it will take more money for you to survive in your later years.
Compound Interest Example
Let’s start simple. Let’s say that you saved $10,000 at a 3% for the next 35 years starting at age 30. Here’s what it would look like.
- Age 30 $10,000
- Age 54 $20,000
- Age 78 $40,000
In this example it would take you 48 years to grow that $10,000 into $40,000. But let me ask you this, how long will you be able to live on $40,000 in today’s dollars? Probably not long.
In the next example we save the same $10,000 but this time at 8% starting at age 30. Here’s what your result would be.
- Age 30 $10,000
- Age 39 $20,000
- Age 48 $40,000
- Age 57 $80,000
- Age 66 $160,000
In this example it would take 36 years to grow $10,000 into $160,000. All because you averaged an 8% return on your money, not bad. Let’s do one more. Let’s say we take that same $10,000 at age 30 and invest it and average a 12% return, here’s what the result would be.
- Age 30 $10,000
- Age 36 $20,000
- Age 42 $40,000
- Age 48 $80,000
- Age 54 $160,000
- Age 60 $320,000
- Age 66 $640,000
Obviously there is a big difference here between saving your money at 12% versus 3%. Now let me ask you this, if you had to choose between the three example which would you choose? Don’t be stupid, pick the last one.
If you’ll also notice in the three examples we didn’t invest anymore money after are initial investment at age 30. So this proves the point the sooner you start saving the more you could possibly earn.
Now, this doesn’t guarantee you’ll earn 12% or any other return on your investment but you can obviously see the impact of what could happen if you would save your money in the wrong places.
How To Avoid This Mistake
There are a few ways you can avoid this mistake and it all starts with prevention. The sooner you can start saving the better. Here are some saving money tips to get you started. Don’t wait until 30, if you can start saving at 18 do it. Why, two reasons.
- You’ll have time on your side. With the extra time you will be able compound you’re money even more.
- You won’t have to invest as much. Starting earlier savings towards retirement will cost a lot less. If you would wait until your 40 it would take nearly 3 times as much to fund your retirement.
However, if you are one of those individuals who have a lot of money saved up in fixed accounts and want to look into investing your money in better places talk to a professional and set up a plan to reinvest your money slowly.
If you are getting back into the market you’ll want to take your time at it. Why you might ask, because sticking all of your money in at once may cause you to buy at a higher price for your funds but by spreading it out over time you’ll be able to buy at cheaper prices. I will talk more about this later in the week, so make sure you sign up to my RSS so you don’t miss a thing.
Till then,
Chris