By Dawn G. Rimari, AIF®, CLTC, Financial Planner
In my practice, I often have discussions with clients about the relationship of risk to return. One of the most common questions that I am asked is, “How can I grow my money with no/little risk?” When it comes down to the options for a client who wants to save or grow their money but not risk the potential of loss of principal investment- there are choices. Usually, those options come with a tradeoff. Generally speaking, the more risk that you are willing to assume with an investment- the greater the potential for return. The less risk you can tolerate- the potential for return will be lower.
At this point it’s important to discuss the difference between saving and investing.
Saving is usually done at the traditional bank. There are multiple reasons for saving. It could be to reach a short-term goal- like saving for a down payment on home. Or, for a large upcoming expense- such as a vacation. Another reason for saving would be to have an emergency fund.
I always recommend that my clients have at least six months of living expenses on hand at the traditional bank. The objective for this money isn’t usually to grow- although that would be nice. The objective is to have this money when you need it for that short term goal. It is important that this money not lose value in a risky investment. I usually tell my clients that if the money is emergency fund money; or, if the goal is less than three years away- that money needs to be at the regular bank.
Another benefit to using the regular bank is lower expenses. Although all banks have fees to access their services, usually those fees will be lower than what you might pay in an investment account with a financial professional. Also, money saved in a traditional bank is usually liquid. Liquid means you can access your money immediately. Some bank instruments (such as Certificates of Deposit) may have short term investment fees if you break the Certificate prior to the maturity date. However, the money is usually easy to withdraw immediately. Finally, most bank instruments are protected by FDIC insurance. This means that if the bank were to fail, your money would still be returned to you through that insurance policy.
Investing is for money that will be used to meet longer term goals. Also, money invested in a long term instrument could be set aside for a non-specific goal at some point in the future. A potential longer-term goal is saving for retirement or saving for college. Money that is invested in most vehicles offered by a financial professional will involve some type of risk. There is almost always potential for loss of principal. And there are expenses that will probably be higher than what you might pay for a savings account at the traditional bank. Further there could be liquidity issues. This means that you may have to allow for an investment to sold in order for you to have access to your money. This could take days or longer depending on the nature of the investment. There is a layer of insurance that can protect against Broker/Dealer failure (SIPC), but, for the most part, any money invested with market exposure is subject to the potential of loss of principal. When working with a financial professional there are a broad number of different types of investments you can choose from- all with different risk profiles, return potential, expenses, and levels of liquidity.
As with most things in life, the risk of any given investment can be located on a spectrum. Most products offered at the traditional bank will offer little risk with potential for low return. Savings accounts, Certificates of Deposit, even Money Market accounts usually pay a low rate of interest that is based on a number of factors- the primary one being the Federal Funds Rate. This is the interest rate set by the Federal Reserve that banks use to make overnight loans to each other. Investment accounts can involve more risk but have a greater potential for return.
It is important that you speak with a financial professional to determine which type of account might be appropriate for your own risk tolerance and goals.