Savings? Checking? Investing? Keep it in cash? It can be difficult to know where to store your money. Here's how to decide.

People ask me this all the time: “Dave, I’m sick of getting a crappy 1% APY on the money in my savings account. How can I earn a better return?”

My response is always another question: “What’s the money for?”

Where you should save or invest your money depends entirely on when you need that money back. Fortunately, this can be simplified a bit:

Where to invest your money depends on how soon you'll need it back.
Let’s break this down.

MONEY YOU (MIGHT) NEED NOW

Your emergency savings (a rainy day fund for unexpected expenses, illnesses or job loss) belong in a regular old savings account. Online accounts pay slightly better than regular bank accounts, but this money isn’t for earning returns, it’s for:

  1. Security (in case you lose your job or get sick).
  2. Paying for stuff in the next year.

Warren Buffett has been known to keep a rainy day fund of around $20 billion. He’s hardly making anything on that cash in today’s economy, but in his own words, he sleeps well at night. Do this, and so will you.

MONEY YOU WILL NEED SOON

You’ve mastered personal finance 101 (a rainy day fund and the makings of a nest egg). Now, you want to save for the good stuff: a car, a house, a wedding, maybe a couple of kids, a bigger house, etc. But the more you save, the more it bothers you that your bank only pays you about 1% interest. Having not slept through all of Econ 101, you recall that inflation historically averages about 3%. What that means, of course, is that if you let your money sit in a savings account for several years, it will start evaporating right before your eyes.

So when saving for purchases a year or more in the future,you want to move cash out of the bank and into an investment where your cash can grow. The downside, of course, is risk. If you don’t know what you’re doing (and even if you do), you could lose money.

Because of this risk, combined with the intimidation factor, most people do nothing. If they have money for mid-term goals, they let it rot in a savings account. If they haven’t yet saved the money, they spend it instead. What you will do (because you’re smarter than everybody else), is open up a brokerage account and pick one, two—or a few at most—low cost mutual funds that are widely diversified and include a healthy amount of bonds. Examples include Vanguard’s LifeStrategy Funds, broadly diversified mutual funds that are managed for risk depending on the time frame you select.

If even this seems like it involves too many decisions, consider Betterment. It’s a site that lets you invest in stocks and bonds in two steps: 1) deposit money and 2) select the percentage of stocks and bonds you want. All you’ll need to do is pay 0.25% for an advisory fee (which is low compared to many other traditional management options).

MONEY YOU WILL NEED LATER (RETIREMENT)

If the money is for retirement, it belongs in an employer sponsored plan à la a 401(k) or 403(b) and a Roth IRA that’s invested in a mix of low-cost mutual funds or ETFs that index the overall markets. Investing for the really long term is easy. The basics are:

  • Choose funds that include stocks and bonds (when you’re young, mostly stocks).
  • Make contributions to your account every month or pay period to take advantage of dollar cost averaging.
  • Sell investments only as part of periodic re-balancing (when you look at your portfolio and make adjustments to ensure the right mix of stocks and bonds for your age).
  • Don’t withdraw money before you retire.

That’s really all there is to it.

A FINAL NOTE ABOUT THE STOCK MARKET

I was having lunch with a coworker recently when he turned to me and—without so much as a trace of humor—said: “I’m going to cash out my 401(k) and put the money under my mattress or buy gold or something, I have absolutely no faith in the stock market.”

My friends’ extreme views are less about money than politics, so my arguments weren’t going to change his mind, but they underscore common sentiments that  the stock market is too volatile for Main Street investors. It’s easy, of course, to say “look at how crazy stocks have been recently”. But when you want the higher returns that come with investing in stock, that craziness is what you sign up for.

It’s true: The stock market is risky! But taking risks is what create rewards. That’s investing. That’s business. That’s life. The key in managing those risks is to not invest like an individual, not a multi-billion dollar hedge fund. Don’t take wild bets. Don’t make short term trades. Buy a mix of widely diversified stocks and bonds and get back to living life.

If this still makes you uncomfortable, there are alternatives to the stock market:

But all involve risk, and most take more know how, time and/or effort than picking a few mutual funds.

What about you? How do you invest money for the short- mid-, and long-terms differently?

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About the author

David Weliver
Total Articles: 304
David Weliver is the founder of Money Under 30. He's a cited authority on personal finance and the unique money issues he faced during his first two decades as an adult. He lives in Maine with his wife and two children.