The Velocity of Money- Saving VS Investing

Building a solid financial foundation requires understanding the distinctions between saving and investing. Although both contribute to a secure financial future, they are distinct concepts. It is crucial for individuals to grasp these differences and determine the appropriate times for saving and investing to maximize their benefits.

While saving and investing share the common goal of improving one’s financial well-being, they diverge in their strategies and purposes. Saving primarily involves setting aside a portion of income for future use. It serves as a means to accumulate funds in a low-risk manner, typically through savings accounts or certificates of deposit. Saving is ideal for short-term goals, emergency funds, or expenses that may arise in the near future. It offers liquidity and easy access to funds, ensuring financial stability during unforeseen circumstances.

On the other hand, investing involves allocating funds with the expectation of generating returns over the long term. Investments are typically made in assets such as stocks, bonds, mutual funds, or real estate. Unlike saving, investing carries inherent risks, but it also offers the potential for higher returns. The primary goal of investing is to grow wealth and achieve financial goals that have longer time horizons, such as retirement planning, and long-term financial freedom.

The Financial Table of Risk

The Velocity of Money, and the Return on Investing

Saving is undoubtedly a safer approach compared to investing, although it may not yield the highest long-term wealth accumulation. However, there are several compelling benefits to consider when it comes to investing your cash:

Potential for Higher Returns: Investing in products such as stocks can offer significantly higher returns compared to savings accounts and CDs. Historically, the S&P 500 stock index has delivered an average annual return of around 10 percent, although it can fluctuate considerably in any given year.
Liquidity: Investing products like stocks, bonds, and ETFs are generally highly liquid, allowing you to easily convert them into cash on most weekdays. This flexibility provides convenient access to your funds when needed.
Beat Inflation: By owning a diversified portfolio of stocks, you have the potential to outpace inflation over the long term and increase your purchasing power. Inflation erodes the value of money over time, so it’s crucial to aim for returns that exceed the inflation rate, currently targeted at 2 percent by the Federal Reserve.

While investing offers attractive advantages, it also entails certain drawbacks to consider:

Lack of Guarantee: Investments do not come with guaranteed returns, and there is a possibility of experiencing losses, especially in the short term, as the value of your assets fluctuates.
Uncertain Returns: The amount you receive when selling your investments may not necessarily match your initial investment due to market conditions and overall economic health at the time of sale.
Long-Term Commitment: Ideally, investments should be held for at least five years to ride out short-term fluctuations. Generally, it’s advisable to maintain investments for as long as possible without accessing them to maximize potential returns.
Need for Research: Investing can be complex, requiring some research and understanding before getting started. However, once you embark on the journey, you’ll discover that investing is feasible and manageable.
Fees: Brokerage accounts may involve higher fees, but many brokers now offer commission-free trades, reducing costs associated with trading.

While saving provides a safer approach, investing offers the potential for higher returns and a higher velocity of compounding additional wealth. Understanding the opportunity cost to saving is a valuable consideration when deciding whether to invest or continue with traditional saving or even 401K routes.

The Opportunity Cost of NOT Investing- APY

When comparing savings account interest rates from different banks, the most effective metric to consider is the APY (annual percentage yield). Unlike simple interest rates, APY takes into account the rate of compounding, making it a more accurate measure of potential earnings.

Each bank determines its APY based on various factors, including the current economic conditions and the bank’s need to attract new deposits. It’s worth noting that a high influx of deposits, especially in a rising interest rate environment, can strain a bank’s resources, as seen in the collapse of Silicon Valley Bank.

Interest rates offered by different banks can vary significantly. While major banks like Bank of America, Chase, and US Bank may offer APYs as low as 0.01%, smaller and more independent banks may provide rates upwards of 1%, 3%, or even 4% in the current market.

To illustrate the impact of APY, let’s consider an example. Depositing $100,000 into an account with a 0.01% APY would yield a mere $10 at the end of the year. In contrast, the same amount in an account with a 4% APY, depending on the rate of compounding, could grow to over $104,000, resulting in several thousand dollars in earnings.

However, it’s important to remember that a higher APY doesn’t always indicate the best product. Just as with cap rates in real estate investment, a higher rate may correlate with increased risk. Additionally, interest rates can fluctuate significantly based on changes in the broader economy.

Actions to Consider Regarding Saving Right Now:

Given the recent economic landscape and historically low-interest rates, a 4% APY may sound attractive. If this inspires you to reassess your budget, reduce unnecessary spending, and save more, it aligns with the goals the Federal Reserve has been promoting through interest rate hikes.

However, if higher APYs tempt you to withdraw from investing (deemed riskier) and focus solely on saving (perceived as safer), you may miss out on substantial long-term wealth creation. Let’s explore this further.

Saving Money vs. Investing in Real Estate:

Traditionally, saving money has been emphasized as a wise practice. Growing up, the adage “A penny saved is a penny earned” resonated, and I aimed to save diligently. As my bank account balance grew, I felt a sense of accomplishment, unaware that inflation was gradually devaluing my money, making it worth less over time.

To combat inflation and build sustainable long-term wealth, I learned to include investing in my financial strategy, particularly in the current economic landscape.

Reasons to Save Money Right Now:

Given the economic shifts and financial uncertainties, saving money can appear as the safest option. Leaving money in a savings account provides some interest, FDIC insurance coverage (typically up to $250,000), and allows easy access to funds when needed.

Building an emergency fund is the top priority for saving right now. Having several months’ worth of expenses saved provides a safety net in case of job loss or unexpected financial challenges.
Even if you already have an emergency fund, bolstering it further in light of inflation, economic conditions, and potential recession discussions can provide added security to navigate future obstacles.
Regardless of accumulated wealth, maintaining a portion of liquid assets is essential. A savings account, aside from storing liquid capital, can generate modest interest during this period.

Downsides of Saving Money Right Now:

Once you have an adequate emergency fund, any additional capital has the potential to generate further wealth, especially considering the opportunities presented in this shifting market. Any idle money loses value daily, as the current inflation rate exceeds 6%.

Furthermore, idle money misses out on tax benefits associated with investments such as real estate, which include cost segregation

How Investing Hedges Inflation Compared to Saving

In the face of inflation and rising interest rates, it becomes crucial to prioritize spending on essential items such as food and shelter. While prices may increase, basic necessities like milk remain a fundamental requirement for most individuals. Adjusting preferences or opting for alternative brands may be necessary, but the need for these essentials persists.

A similar principle applies to multifamily real estate. Despite the substantial rise in rental rates, the demand for rental properties remains robust and continues to grow. People require housing and are willing to pay higher rents to secure a place to live. Investing in these essential assets can offer a stable and favorable long-term path to wealth accumulation.

Moreover, real estate investment provides significant tax benefits, further enhancing wealth creation opportunities. It’s important to consider factors such as liquidity needs, investment objectives, risk tolerance, desire for passive income, and current investment portfolio when making decisions about venturing into real estate as part of your overall personal finance and investment strategy.

Measure the Opportunity Cost of Saving

Let’s examine the potential outcomes for your wealth creation based on different approaches. Consider a hypothetical situation where you have $100,000 in excess capital beyond your emergency fund and reserves.

Option 1: Saving the $100k If you choose to leave the $100k in a savings account with a 4.0% APY, the growth over 20 years would amount to $219,112. However, when factoring in an average inflation rate of 3% per year, the real value of the final amount would be equivalent to $121,317 in today’s money.

Option 2: Investing the $100k in Real Estate Alternatively, investing the $100k in real estate syndications with a projected equity multiple of 1.7x over 5 years could yield substantial returns. Assuming conservative cash flow distributions, the investment could grow as follows:

Year 1: $102,500
Year 5: $170,000 (including the sale of the asset)
Year 10: $289,000
Year 15: $491,300
Year 20: $835,210

Considering the same 3% inflation rate, the final amount would still be worth approximately $462,436 in today’s money, indicating significant wealth creation over two decades.

Option 3: Delayed Real Estate Investment Delaying real estate investment for five years while saving the $100k at 4% APY during that period would result in a final capital of $597,740 after 20 years. However, compared to the $835,210 potential from immediate investment, the opportunity cost of waiting becomes evident, amounting to $237,470.

These scenarios illustrate the impact of different choices on wealth creation and the velocity at which wealth can accumulate through investing.

How Real Estate Investing Accelerates Wealth

Ultimately, the key takeaway from these scenarios is that investing in real estate is essential for long-term wealth creation. Allowing your money to remain idle in a savings account results in a loss of value over time. The opportunity cost of not investing can have significant implications not only for you but also for your family and future generations.

Therefore, it is crucial to take action and educate yourself about real estate investment options that align with your goals. Even if you are not yet prepared to invest in real estate syndications, conducting research and exploring different avenues such as rental properties, short-term rentals, mutual funds, money market accounts, real estate investment trusts, the stock market, or exchange-traded funds can provide valuable insights.

Each investment option has its own advantages, disadvantages, and considerations such as risk tolerance and capital gains tax. Conducting thorough due diligence is vital.

The important point is to take action, whether it involves consulting a financial advisor, joining a real estate-focused community like the Viking Investor Club seeking advice from friends and family with investment experience, or even engaging in stock market simulation games.

While others may be hesitant and paralyzed by inaction, now is your opportunity to seize some of the best investment opportunities available and exponentially grow your wealth.