As a physician, I spend years delaying my financial gratification. Years not buying what I wanted, doing what I wanted, waiting to have kids and waiting for the day when I would finally have money in the bank. Once I started making a reliable income I felt hesitant to invest. I had worked so hard to build an income so why not just leave my money in savings? However, what I didn’t realize at the time was that inflation was quietly chipping away at the value of my savings.
The truth is, your money doesn’t just sit there. When you deposit your money into a savings account, you’re effectively lending it to the bank. And just like when you take out a mortgage to buy a home, you pay interest on that loan, and the bank pays you interest on your savings.
Interest is essentially the cost of borrowing money, but in the case of your savings account, the roles are reversed. You’re effectively lending money to the bank, and they’re paying you interest on that loan.
So, where does the interest rate you earn on your savings come from? The bank takes your deposited money and invests it, often into relatively low-risk investments like treasuries and bonds. Ideally, these investments generate returns above and beyond the interest rate the bank is paying you, and thus the bank makes its money on that spread.
But what about you? Even though you may not be getting those additional returns, this isn’t necessarily a bad deal for you. Why? Because your money is both secure and liquid. But, is this a good deal for you? Not necessarily. Let’s dive in a little.
APY Savings Account Examples
APY is the total amount of interest you earn on your deposit over the course of a year, expressed as a percentage. This is different from the interest rate, which is the amount you earn each month or quarter. The APY takes into account how frequently the interest is compounded and added to your account balance.
To better understand the impact of APY on your savings, let’s look at a simple example. Say you deposit $100,000 into an account earning 0.01% APY. At the end of the year, your account balance would be $100,010 – earning you a mere $10 in interest. However, if you were to deposit that same $100,000 into an account earning 4% APY (depending on the rate of compounding), your account balance would grow to $104,000 or more, earning you several thousand dollars in interest.
But just like with any investment, a higher APY doesn’t necessarily mean the best product. Higher APYs often come with increased risk, just as with cap rates on investment properties. And, it’s important to keep in mind that interest rates can fluctuate drastically based on changes within the broader economy.
So, when choosing a savings account, make sure to weigh the APY and any potential risks against the security and liquidity of the account.
If the higher APYs are tempting you to pull back from investing (which may seem “riskier”) to saving instead (which may seem “safer”), that might actually cheat you out of substantial wealth creation over the long term.
Saving Money Versus Passive Investing in Real Estate
When I was younger, my parents instilled in me the importance of saving money. Like many of us, I took this lesson to heart and made it a priority to save as much as I could, especially after medical school. Watching my bank account grow over time gave me a sense of accomplishment, and I felt like I was on track to achieve my financial goals.
However, what I didn’t realize at the time was that inflation was quietly chipping away at the value of my savings. Inflation is the gradual increase in the cost of goods and services over time, and it means that the same amount of money will be worth less in the future than it is today.
As an example, let’s say I saved $100 in a bank account with a 2% interest rate. At the end of the year, I would have earned $2 in interest, bringing my total to $102. However, if inflation is 3%, then the cost of goods and services will have increased by 3% over the same period. That means that my $102 can now buy me less than it could have a year ago. In other words, I’ve lost purchasing power even though my bank account balance has grown.
This is where investing comes in. Unlike a savings account, which typically offers low interest rates that may not keep up with inflation, investing can offer the potential for higher returns that can outpace inflation over time.
Of course, investing does come with risks, and it’s important to do your due diligence and understand the potential downsides. But by diversifying your portfolio and investing for the long term, you can build sustainable wealth that can help you achieve your financial goals.
In today’s economic landscape, where inflation is on the rise and interest rates are low, investing is more important than ever. By embracing the power of investing, we can build a brighter financial future for ourselves and our families. So if you’re still just relying on your savings account to grow your wealth, it may be time to consider adding investing to your toolbelt.
Savings vs Investing Options
Option 1: Saving Your $100k
If you were to do nothing and leave your $100k in a savings account with an annual percentage yield (APY) of 4.0%, your money could grow significantly over the next 20 years. However, if we factor in the average inflation rate of 3% per year, the $219,112 you would end up within 20 years would only be worth around $121,317 in today’s money.
Example:
- Year 1 – $104,000
- Year 2 – $108,160
- Year 3 – $112,486
- Year 4 – $116,985
- Year 5 – $121,665
- Year 10 – $148,024
- Year 20 – $219,112
While this may seem like a good return, don’t forget about the stealth ninja that could negatively impact your savings growth – inflation. Assuming an average inflation rate of 3% per year over the next 20 years, your $219,112 in 20 years would only be worth $121,317 in today’s money. Suddenly, your return of $21,317 over 20 years doesn’t sound so great anymore.
Option 2: Investing Your $100k in Real Estate Now
While the initial returns may be slower due to conservative cash flow assumptions, the numbers take off dramatically after the first few years, and the final number of $835,210 beats the savings example by a whopping $616,098. This is essentially your opportunity cost – the potential wealth you could have created if you had invested instead of saving.
Even factoring in the same 3% inflation rate over 20 years, your $835,210 is still worth roughly $462,436 in today’s money, meaning you would have more than quadrupled your money in those two decades, even when accounting for inflation. Additionally, investing in real estate comes with tax benefits that can further enhance your wealth-building journey.
Example:
- Year 1 – $102,500 ($100k invested in Syndication #1, plus 2.5% cash flow)
- Year 2 – $105,000
- Year 3 – $110,000
- Year 4 – $115,000
- Year 5 – $170,000 (factoring in the sale of the asset)
- Year 10 – $289,000 (started with $170k invested in Syndication #2, exiting at a 1.7x equity multiple after 5 years)
- Year 15 – $491,300 (started with $289k invested in Syndication #3, exiting at a 1.7x equity multiple after 5 years)
- Year 20 – $835,210 (started with $491k invested in Syndication #4, exiting at a 1.7x equity multiple after 5 years)
Option 3: Waiting to Invest Your $100k in Real Estate
Finally, let’s consider the cost of inaction. If you wait five years to invest your $100k in real estate, you may miss out on potential opportunities in the market. While it’s impossible to predict exactly what will happen in the future, by waiting, you’re potentially giving up the chance to snowball your investments and potentially miss out on significant returns.
Ultimately what these varying options have represented with our clients is the difference in retirement.
Here is an image that shows the tales of two different retirements, and how ultimately, your retirement depends on an investment strategy.
Any additional money you’re not putting to work for you is losing value day by day. The inflation rate in recent months continues to be well above 6%, which means that, even if you were able to put your money into an account with a 4% APY, your money is still losing value. Further, because any idle money is not able to take advantage of tax benefits (e.g., cost segregation and depreciation as with real estate investing), you’re also missing out on that wealth creation opportunity. So what should you do with any excess capital you have right now? Rather than use that excess capital to fuel a false sense of security (and thus miss out on real wealth opportunities), let’s consider the case for investing – particularly in stable, long-term investments like real estate.
How to start Investing
Inflation is driving prices up, and interest rates are encouraging people to save more money. However, there are still basic necessities, such as food and shelter, that people must continue to spend money on, regardless of the cost. This includes multifamily real estate, which has remained a stable investment despite rising rents.
For example, a carton of eggs may have been $5.99 last year, but now it costs $7.99. People may choose to buy a cheaper brand of eggs or forgo certain labels, but ultimately, they still need to buy eggs. Similarly, even as rental prices have increased significantly over the last several months and years, rental demand remains strong. People still need a place to live and are willing to pay higher rates.
Investing in basic necessities, particularly in a shifting economy, can be one of the best and most stable long-term avenues to grow wealth. Real estate is an excellent example of this. Investing in real estate provides significant tax benefits, which can further accelerate wealth creation.
However, before investing in real estate, it’s important to consider factors such as liquidity needs, investing goals, risk tolerance, desire for passive income, and current investment portfolio. These factors can help determine whether and how to venture into real estate investing as part of an overall personal finance and investment strategy.
Ultimately, the decision to save or invest your money depends on your personal financial goals and risk tolerance. If you’re looking for a conservative, low-risk option we have found that multifamily investment offers the opportunity for a low-risk, low-maintenance option, but has a higher return rate than a savings account.
As always, it’s important to do your own research, consult with a financial advisor, and make informed decisions about your money.
