The best place to keep your savings …

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Where do you keep your money if you want to buy a house in, say, 7 years?

If you keep it in the bank, you’ll find rates up around 5% if you can commit to a 5 year term.

Given that inflation is currently running around 1.7%, you’re heading for a very small gain.

That’s why many choose to put their money into mutual funds …

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Despite the crash, returns from investing in a low-cost Index Fund (say, one that mirrors the S&P500) have been up to 28.6% for any 5 year period that you care to nominate in the past 85+ years.

Now, that’s certainly a lot better than CD’s (long-term bank deposits).

But, there’s a catch … and, it’s a big one!

Whilst’s CD’s virtually guarantee their admittedly paltry return, there’s no guarantees in the stock market …

… and, there has been at least one 5 year period where the S&P500 has lost 12.5%.

But, let’s look at the downside v the upside: that’s a potential 12.5% loss each year for the 5 years … compounded (meaning your savings will halve in a little less than 7 years) … but, you may gain up to 28.6% annual return (meaning you may double your savings every 2 years).

Compare that to the measly 5% return (before inflation) from CD’s and it seems like no contest, which is why many Americans are opting to use mutual funds as a mid-term savings vehicle, but …

It’s a huge mistake.

You see, it might be fine if you already had the deposit for the house saved up, and you were just setting it aside for 7 years. If so, and if this were me, I might very well elect to buy units in a low cost Index Fund rather than scraping by with a CD.

But, if I had the deposit already, I would more likely just go ahead and buy the house now, and rent it out if I wasn’t yet ready to live in it.

But, the reality is that most people need that 7 years to save for their deposit. And, that’s a whole different ballgame, because now you are putting aside a little every month and, over that 7 year period, slowly building up your deposit.

This means, your money is really only going to sit in your investment or savings account on average just for 3 years.

Now, your risk of loss is up to 27%, almost as much as your potential gain of up to 31%, and that means you are gambling, not saving.

This is one of very few cases that I have found where common financial wisdom is correct …

… the minimum period for committing your funds to the stock market should be 5 to 10 years, assuming you are not prepared to gamble with your starting capital.

And, if you are prepared to play the market, well, that’s a subject for a whole other post …

So – and, unfortunately – the best place (indeed, the only sensible place) to keep your money safely parked for up to 7 years is in CD’s šŸ™

 

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3 thoughts on “The best place to keep your savings …”

  1. Adrian,

    I’ve puzzled over this question as well.

    Are there alternatives to CDs that you might consider? What about lending money through prosper.com or a similar outfit?

    Best,

    James

  2. Pingback: The myth of asset allocation …- 7million7years

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