By Alex Thomas Salder, clarkhoward.com
While stashing money under your mattress in college probably worked fine, if you want to build long-term wealth, that’s not the way to do it.
But according to a new survey, an alarming number of American adults still haven’t broken the habit — and it’s going to cost them a lot of money in the long run.
Why stashing your cash is not a smart move
According to the new survey from Bankrate, 23% of American adults think the best way to invest money they won’t need for at least 10 years is either in a savings account or in the form of CDs (certificates of deposit).
But it’s not. In fact, both of these options would actually cause you to lose money — at least in terms of spending power.
“Right now, especially, you’re getting practically no interest from cash investments like savings accounts and CDs,” Avani Ramnani, CFP and director of financial planning and wealth management at Francis Financial, told Bankrate.
According to the Bankrate report, “Ramnani says she’s ‘concerned that so many people think that’s such a good investment for such a long period of time.’ Because while deposit accounts do protect investors against losses, they don’t protect them from the inflation that will eventually make the invested money worth less.”
So there are really two reasons why long-term cash investments are a bad idea:
- When you consider inflation over a 10-year period, by the time you take your money out, it will actually be worth less than it is today.
- Plus, you miss out on any money you could earn by investing that cash in the stock market over the same 10-year period.
So while these options are good for short-term investments — since the money is easily accessible — there are much better options for your long-term investments.
“Over the long period of time, we’ve seen that the stock market returns between 6-7% from a diversified portfolio,” says Ramnani — which is a lot more than the cash options people preferred in the survey.
What’s causing people to hold on to cash
According to Bankrate, there are two primary reasons people are holding on to cash: fear and a lack of knowledge about investing.
Cash makes people feel safe, and when you don’t know much about investing, getting started can be intimidating.
But the people who tend to prefer cash most actually have the most to gain if they were to invest their money instead.
According to the survey, “millennials were the generation most likely by far to value cash investments above the others, with 32% of those between ages 18 and 35 endorsing cash, including a whopping 43% of younger millennials ages 18-25.”
Better alternatives for your long-term investments
Savings accounts and CDs are good for short-term investments, because you can access the money fairly easily if you need it.
But when it comes to money you don’t need for at least 10 years, investing in index funds is a much better strategy. And you don’t need to be an expert investor to do it. In fact, you don’t need any experience at all.
Index funds are the most cost-efficient way to get started on longer-term investing, because they require very little work on your end — plus, they’re cheap.
What is an index fund?
An index fund is a type of mutual fund, which takes investments from individual investors and pools them together to buy baskets of securities.
Here’s how an index fund is different from a traditional (or managed) mutual fund: According to fund tracker Morningstar: “A mutual fund is a basket of stocks, bonds or other types of assets that is professionally managed by an investment company on behalf of investors who don’t have the time, know-how or resources to buy a diversified collection of individual securities (stocks, bonds etc.) on their own. In exchange, the fund charges investors a fee, which may be around 1% or more — meaning investors would pay about $100 for every $10,000 they invest.”
Since mutual funds are more actively managed by a professional, they are more expensive for investors, because the professional has to pick and choose which stocks they think will overperform. This is why an index fund is a better option for beginner investors.
Rather than having a professional pick and choose individual stocks, with an index fund, you own all or almost all of one particular kind of investment. One index fund can invest in hundreds (and even thousands) of stocks or bonds in one single fund. So you are investing in an index. The Dow, S&P 500, Nasdaq 100 — these are all indexes.
The most popular type of index fund is the “500 index.” It holds little pieces of the 500 largest companies in the United States — and when you invest in it, you become a part owner in each of these companies.
So since an S&P 500 index fund owns stock in all 500 of those companies — when the S&P 500 Index goes up, your fund goes up; when it goes down, your fund goes down.
There are also tons of other choices of index funds. Here are some examples: You can own a mid-size company index; a small company index; an international index; an emerging market index (think Third World countries); a government bond index; a corporate bond index; a real estate index fund and on and on.
Index funds are sometimes referred to as “passive” mutual funds — because they take a hands-off approach to investing. When you put your money in an index fund, you’re investing in a broad range of stock or bonds (again, usually an entire market), so you don’t have to deal with — or do the research associated with — buying and selling individual stocks. You also don’t have to pay the management fees you would with a mutual fund.
For more information follow this link, clarkhoward.com