The Jets vs. the Giants. Red states vs. blue states. Man vs. Food. Our society tends to set up competitions in relation to most things. There are times, however, when the options on both side of the ledger have merit. While you should make comparisons when thinking of saving and investing, a diversified plan requires several components. Savings accounts, or similar products, and stock investments should both play a role in most people's plan.
Saving and investing are two different things. When you save, you don't expect much of a return. You put money in a product that carries absolutely no risk. You cannot lose money in a savings account; the federal government, through the Federal Deposit Insurance Corporation, or FDIC, insures their value, up to a limit. When you invest money, however, you automatically assume a level of risk. Generally, your goal is to achieve a relatively high rate of return, but you must balance the desire to make money with your tolerance for losing it. Most investors, particularly those with quite a few years left before retirement, use stocks, in some form, as a large part of their investment scheme.
Savings accounts and stock investments serve practical purposes. People tend to keep savings accounts for one of two reasons: to save for a near-term purchase or to keep an emergency fund. If you want to buy a large-screen TV, save for a down payment on a house or purchase a new horse for your ranch next year, a savings account probably makes sense. The same goes for an emergency fund, which is usually equal to three to six month's worth of expenses. For either of these purposes, the last thing you want is to lose money in a stock market downturn. If, however, you have several years before a big purchase or retirement -- exactly how many years varies with several factors, including how much money you have, your tolerance for risk and market conditions -- taking on some risk in the stock market makes sense. You can afford to suffer some temporary losses on paper to, hopefully, reap rewards as your stocks rise in value.
Savings accounts typically don't trigger a major tax headache. You earn interest on your savings account value. Your bank probably pays it out monthly. At the end of the year, the bank sends you a 1099-DIV form, and you report the interest earned to the IRS. It becomes part of your taxable income. Stocks are not so straightforward. When you sell a stock, you incur either a capital gain or a loss. You must report all gains to the IRS; you can use losses to offset capital gains and reduce your taxable income. Even if you don't sell a stock, it can trigger a taxable event. If a stock you own pays a dividend, your brokerage sends you a 1099-DIV at the end of the year. You must report, and pay taxes on, all dividend income you receive.
If you have enough money, consider a money market deposit account over a savings account. You can open a money market account at a bank, but its minimum deposit requirements are definitely higher than those of a savings account. In return, banks likely offer a higher interest rate on money market market accounts. Money market deposit accounts differ from money market mutual funds. The FDIC ensures the former, while the latter, although pretty conservative, can lose value. If you're skittish about investing in individual stocks, you can do an end-around. If you purchase shares in a stock mutual fund, you assume indirect ownership of the companies it holds, with a professional money manager making the investment decisions for you and other mutual fund shareholders.
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