In the last few weeks I’ve had the topic of high-yield savings accounts come up in conversation several times. One of the instances was during a conversation with friends. They were listening to some podcasts and high-yield savings accounts were being touted as a great place to put funds. So, they asked my opinion on how to begin investing, and if a high-yield savings account was an appropriate place to grow some wealth.
The rest of this article is going to recount a bit of the information I gave to them on high-yield savings accounts and why they’re not appropriate for building wealth at this time. Then, I will transition to information and best practices on how to begin investing.
What are High-Yield Savings Accounts
We’ve all heard the term savings account, and high-yield savings accounts are accounts that banks have created that have a higher-yield than a traditional savings account. The FDIC indicated in March of 2021, that traditional savings account rates averaged .06% average percentage yield. In comparison, high-yield savings accounts can reach up to .5% average percentage yield.
That’s a big difference! So, it sounds like a great deal. But is it?
Why I Don’t Recommend High-Yield Savings Accounts
At the same time as the report for the FDIC, the inflation rate in the U.S. was 2.6%. So, if you put your funds in a high-yield savings account returning at best .5%, and inflation is 2.6%, your purchasing power is decreasing by somewhere around 2.1%. That’s not a good deal for anyone!
Additionally, you can find checking accounts with interest rates at or around 2%. Typically these bank accounts are associated with credit unions. Important to note, though, is that these checking accounts typically require at least one direct deposit and a certain number of transactions (between 10-15 is the normal) per month to be eligible for the interest. Because these accounts are much closer to inflation rates, they do a much better job of minimizing the risk of losing purchasing power.
So, compared to a savings account, a high-yield savings account sounds better. However, you’ve lost the forest for the trees. They don’t keep up with inflation and there are checking accounts to return higher amounts of interest. The big picture is that high-yield savings accounts are not an appropriate vehicle in today’s financial environment.
The One Reason to Have a High-Yield Savings Account
So, my recommendation to most would be to find a checking account returning above 2% and use it as your checking and as an emergency fund. Maintain a certain level of funds in the account (whatever 3-6 months of expenses is for you), and then anything above that is what you have to spend. This allows your emergency funds to be readily accessible if needed.
However, the one time I would recommend a high-yield savings account, is if that system simply does not work for you and having funds in a savings account, in a secure and easily accessible place helps you to sleep at night. If it gives you peace of mind, that is worth a lot to me.
However, know that putting the money in that account is not growing you any kind of wealth. It is my recommendation that the account not have more than three or five thousand dollars. Perhaps a good amount to have at max is the deductible on your home insurance.
So, in the conversations that I’ve had recently, they asked how I would begin investing if not in a high-yield savings account? My answer: in an investment account.
How to Begin Investing
I’ve written a previous blog post on investing for beginners, so I don’t want to go into too much of the same information on the mechanics of investing. Instead, here I’m going to talk more about the theoretical aspects of how to begin investing. If you want mechanics, head over to that post!
The First Purpose of Investing: Retirement
It is critical that we all start saving for retirement as early as possible. There are a number of vehicles through which to invest for retirement.
If an individual is young or has a summer or hourly job after school (such as babysitting, working at the local grocery store, etc.), then likely the best place to invest is through an IRA investment vehicle (likely a Roth IRA in today’s tax environment).
If an individual is in their working years, looking at the investment options through an employer is likely the place to start. If there is an employer-sponsored 401k or 403b, there is likely a benefit to having funds deducted by payroll and automatically invested. If an employer has a match, it is critical to always take advantage of at least the match.
The key to investing for retirement is to invest through a retirement vehicle (401k, Traditional IRA, Roth IRA), so that as you change investment strategies over time your funds grow tax deferred. Let me give you an example of what this means. Say you invest a certain amount today in an index fund or mutual fund. You leave that money to grow over the next few years. At some point in the future you choose to sell the index or mutual fund and buy a different fund. In a brokerage account, there would be a taxable event at the sale. If it is in an IRA or Roth, it is not a taxable event.
Choosing the Proper Investments
Now that you have chosen what you want to invest for as you begin investing and have a proper account type, it’s time to invest the money into investments. Until the funds are invested, they’re sitting in a money market account, which have virtually no interest (typically around .07% at this time). If I wasn’t a fan of .5% interest on a high-yield savings account, I’m definitely not a fan of .07% in a money market fund.
I want to be clear that I am not a registered investment professional. It is not my place to tell you what specific investments you should or should not be invested in, and in this article I am not recommending any specific investment. Choosing investments is a completely personal choice and needs to be based on your goals, your financial situation, your confidence with investing, your risk tolerance, and more.
MPower Co prides itself on not soliciting investments or making recommendations. First, it’s not legal for us to do so, and second, by the time you saw an article with recommendations, it would be outdated (beware of articles on investing being untimely!).
But you are here for how to begin investing, and you need to know a few things in order to be savvy in making confident decisions.
The Risk Pyramid for Investments
Because we like to think of things in terms of risk within investing, the risk pyramid was born. I first learned about this in college. The lower on the pyramid, the lower the return is likely to be (so the higher inflation risk there is) but the lower the risk of losses. As you go up the pyramid, the upside gets larger but so can the downside.
Know that there is a continuum in the investment world. One bond to another can have a different risk level, for instance a AAA rated bond is much safer than a C or junk rated bond. This pyramid also does not include every type of investment (i.e. index funds, exchange-traded funds, penny stocks are not listed).
Investment Types Most Appropriate for Beginners
If you are a beginning investor, starting in the middle of the pyramid likely makes the most sense in today’s world, especially when investing for retirement. You have time if life happens to the markets and you want to be growing wealth that will compound so you can enjoy your retirement years.
The base part of the pyramid all falls into the issue I talk about with not keeping up with inflation. It may be secure, but your purchasing power is decreasing significantly (especially given the current inflation rates). You need enough in those types of accounts where you feel secure. You can pay your bills and credit cards each month (if you can’t do this through your cash flow- you have an entirely different area to focus on – a spending plan – but that’s for another article!), but not so much that you’re not growing any wealth.
In the middle of the pyramid, focus on finding investments that are low fee, lower risk, and starting with those types of investments to build up your investing confidence. Research shows that the more you spend in commissions, fees, and other costs associated with investing, the smaller amount you have actually invested. Research shows that index funds are the sweet spot when it comes to minimizing risk and maximizing returns (because index funds are sufficiently diversified and have low fees).
Here comes in the kicker, if you are investing for retirement through an employer sponsored plan, you likely only have a couple of dozen investment options. The retirement plan committee selects investments that are approved. Reviewing your list of approved investments through the FINRA’s tool the Mutual Fund Analyzer (I’ve mentioned this in other posts) is the best way to select your investments or to work with the representative that your company works with to make a recommendation to you.
If you’re investing for retirement through an IRA, you likely have the world at your fingertips.
Choose Safety Over a Get Rich Quick Mentality
For beginning investors, it’s natural to want to see something exciting happen over night. If you are focused on how to begin investing properly and building good habits, choose investments that you feel confident in and can sleep at night without having to check them right before going to sleep each night or first thing in the morning before coffee.
As you grow your confidence, and build your financial foundation in investing you can branch out into more fun and exciting investment types. But for now, focus on a more lower to moderate risk investment types.
Think of it another way. You don’t want to bet your retirement on one stock, because what if an Enron (remember them?! I do.) situation happened with that one stock? You don’t want to work to save for retirement and get your employer match year-after-year to be near retirement and have nothing.
Building wealth for retirement is a bedrock of building a financial future, therefore it is a great place to start with investing.
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