When you start having money of your own, you have to decide how you want to invest it. If you're deciding whether to put your money in a savings account or invest in stocks, you have to balance your desire for a high rate of return with your risk tolerance.
Savings accounts are very low maintenance: You put your money in the account and you can leave it there with no further activity on your part. Each month, the bank pays you interest. With stocks, you need to be a little more hands-on. You have to decide how you want to invest your money by picking companies. Over time, you can buy and sell shares of different companies as the market changes. You typically pay a commission, however, each time you buy or sell shares.
When you put your money in a savings account, your return depends on the interest rate offered by that account, which you know when you put your money in. For example, if your savings account pays 2 percent interest, you'll earn $2 for ever $100 in your account each year. Your return isn't based on how well the bank does. Stocks, on the other hand, generate a return based on how well the company performs. If it does well, you could have a return that's substantially higher than the savings account. But, if the company has a bad year, you could lose some or all of your original investment.
Savings accounts are one of the safest places you can put your money, in large part due to the Federal Insurance Deposit Corporation. The FDIC insurance protects the first $250,000 of your deposit accounts, including your savings account, at each bank in case the bank goes bankrupt. Stocks, on the other hand, don't have the same protection. If the company that you buy into goes out of business, you can lose your entire investment.
Savings accounts and stocks are also taxed in two different ways. With a savings account, you pay taxes on the interest you receive each year and the interest is taxed at your ordinary income tax rate. With stock, you don't pay taxes on any gains as long as you continue to own the stock. When you sell the stock, you pay taxes on the gains. If you owned the stock for less than one year, you pay taxes at the ordinary rates. If you owned the stock for over a year, you pay the lower long-term capital gains rates.
- USAA: Reality Check: Start Building Your Financial Future Now
- FDIC: Insurance or Not Insured?
- IRS: Topic 409 -- Capital Gains and Losses
- National Credit Union Administration. "Share Insurance Fund Overview." Accessed Sept. 6, 2020.
- FDIC. "Transparency & Accountability - Consumer Protection & Deposit Insurance." Accessed Sept. 6, 2020.
- Federal Reserve. "Regulation D, Reserve Requirements," Page 3. Accessed Sept. 6, 2020.
- Ally. "Online Savings Account: High Interest Savings, Rates & Reviews." Accessed Sept. 6, 2020.
- Capital One. "Online Savings Accounts: Performance 360." Accessed Sept. 6, 2020.
- Consumer Financial Protection Bureau. "What Is a Certificate of Deposit (CD)?" Accessed Sept. 6, 2020.
Based in the Kansas City area, Mike specializes in personal finance and business topics. He has been writing since 2009 and has been published by "Quicken," "TurboTax," and "The Motley Fool."