Building a Solid Financial Foundation: Start Investing with a Savings Account
How a savings account can be your first step into the world of investing.
If you would like to start investing some of your income and have been reading a ton of personal finance blogs, the contradiction in this title most probably got you thinking that I might be out of my mind.
Investing doesn't always have to involve complex strategies or high-risk options. In fact, a savings account can serve as your starting point, as it was for me, and that is what I intend to share with this article.
What is a Savings Account?
A savings account is a deposit account you might have at a bank or other financial institution, that generates a small percentage of the initial money invested as a return on a predefined recurrence.
How They Work
Savings accounts are widely available at banks and financial institutions. They serve as an important and stable source of funds used for lending. These institutions generate revenue from interest, fees, and various cross-selling opportunities.
When you open a savings account, you deposit money into the account, and the institution pays you interest on the balance you maintain. The interest rate is typically expressed as an annual percentage yield (APY), which represents the total amount of interest expected for that account in a year.
Over time, your savings account balance can increase as the interest compounds. Compounding means that the interest you earn is added to your initial balance, allowing your money to grow.
The Problem With Savings Accounts
While savings accounts offer stability and accessibility, it's essential to understand their limitations as well. Here are the main reasons why financial experts often advise against relying solely on savings accounts for long-term wealth-building:
Low-Interest rates: Savings accounts may offer lower returns compared to other investment options. Although interest rates may vary, they are generally lower than the returns available through higher-risk investments.
Lack of wealth-building potential: To build significant wealth over time, diversifying your investments and allocating funds to assets that have the potential to outpace inflation is crucial. Savings accounts may not provide the growth necessary to achieve long-term financial goals.
Inflation risk: Over time, the price of goods and services increases, leading to inflation. The interest earned from a savings account may not keep pace with inflation rates, resulting in a decrease in your purchasing power.
What a Savings Account is Perfect For
When analyzed closer, the most prominent reason on why savings accounts are taken out of the picture is when considered as the primary means of investing, which is not the application intended in this article.
If you would like to start investing, I would say that a savings account should be your primary step. Treasury Bills could also be an option here but that brings another level of complexity.
Your savings account can surely be used to build your emergency fund.
An emergency fund is a sum of money you set aside for unforeseen expenses or emergencies. It acts as a safety net, helping you avoid going into debt or withdrawing funds from future investments. Financial experts generally recommend saving three to six months' worth of living expenses to cover essential costs such as housing, utilities, food, and transportation.
Keep in Mind
When it comes to your emergency fund, the primary goal is to have money readily available rather than focusing on maximizing returns. Here are some tips to make the most of your savings account:
Research and compare different savings account options to find the ones that offer the highest interest rates.
Choose a savings account that compounds interest, which means that your interest earnings are added to your initial balance.
Set up regular automatic transfers from your checking account to your savings account.
Most savings accounts have restrictions on the number of withdrawals you can make without incurring fees. Therefore, avoid them, and if you really need to - minimize them.
Starting your investing journey with a savings account can be a prudent first step. While savings accounts may have their limitations, they play a crucial role in building an emergency fund and providing stability.
As you progress on your financial journey, consider exploring additional investment options and seeking professional advice to create a well-rounded investment portfolio. Remember, financial decisions should always be tailored to your individual circumstances and long-term goals.
Have fun! ;-)
Reference(s):
Investopedia. May 27, 2023 (2023, May 27). What Is a Savings Account? Retrieved from www.investopedia.com/terms/s/savingsaccount.asp