Savings are, by definition, safe. You can turn your back and they won’t escape. When the stock market crashes, they’re unalarmed. Every time you look, they’ve earned more interest. You’re never going to lose a dime.
Investments, by contrast, put your money at risk. Good investments yield much more than savings over the long run. But you have to put up with losses too.
Savings will not make you rich. Only canny investments do that. The role of savings is to keep you from becoming poor. They’re your security. Your base. They preserve your purchasing power. With enough savings tucked into your jeans, you can afford to take chances with the rest of your money, and with your life.
Should You Invest Rather Than Pay Down Debt? These are tricky calculations and depend on your options. My priorities look like this:
1. Invest in a tax-favored retirement account. If you have a 401(k) with a company match, put in as much as you need to capture the match in full. Then …
2. Pay off high-rate consumer debt. It gives you the highest guaranteed investment return you’ll ever earn. Then . . .
3. Build an emergency cash reserve for personal security. I call this your Cushion Fund. Cash savings don’t earn high interest rates but help ensure that you’ll always be able to pay your basic bills. Then . . .
4. If your kids will go to college, start college investment accounts. Aim to accumulate half the probable cost, planning to pay the rest out of current income and student loans. You might get a tuition discount too. Then. . .
5. Return to your tax-favored retirement investments. Start putting in the maximum the law allows. If you’re already at the max, invest in regular after-tax accounts.
Is It Better to Prepay Your Mortgage or Use Your Extra Cash to Invest?
That depends on your age and the interest rate. Here’s how to look at it:
1. If you’re young or in early middle age, it’s more important to con¬tribute to a tax-favored 401(k), Individual Retirement Account, or other retirement plan. If you’re contributing the maximum, open a regular, taxable investment account. Over the long run, they’ll be the better investment.
2. If you’re approaching retirement, it’s important to get your mortgage paid off. If you can’t, plan on selling the house and buying something smaller for cash when your paycheck stops. The easiest way to live in retirement is in a mortgage-free home.
3. If you’re paying a punishingly high mortgage interest rate, prepay your loan as fast as you can. You need to accumulate more equity so that you can refinance into a loan with a lower rate.
From MAKING THE MOST OF YOUR MONEY NOW by Jane Bryant Quinn. Copyright © 1991, 1997, 2009 by Berrybrook Publishing, Inc. Reprinted by permission of Simon & Schuster, Inc.