Cash Savings vs. Retirement Savings: Which is Right for You?

Saving and investing are two different ways to prepare for the future. In my opinion, the difference between saving and investing boils down to risk tolerance and time frame.

Generally, savings should be used for short-term planning and investing for long-term planning.

Strong financial planning calls for a mixture of both saving and investing, and today’s question is about how to balance cash savings and investing for retirement.

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Cash Savings vs. Retirement Savings

Where Should You Focus?

A: Hi Penelope, thanks for contacting us. I’ll start off by saying you’ve done a good job so far by making smart financial decisions and not amassing any consumer debt.

With some additional planning, you should be in a nice position to meet your goals of increasing both your retirement savings and your cash savings.

Let’s look at a couple of options, and hear the opinions of two other members.

As you mentioned, we are not professional financial advisors, so this is just a look at your options, not advice telling you what you should do! I recommend visiting a fee-only financial planner for more specific information.

Goal 1: Increase Retirement Savings

If you got a late start on your retirement investing, you’ll likely want to catch up as much as you can while you and your husband are in your prime earning years and don’t have any children or other major expenses.

401k vs. Roth IRA

I think Roth IRAs are a great deal, and I recommend opening a Roth IRA if you fall in the income limits. It’s important to understand their advantages.

Take some time to read about and understand the differences between 401k plans and IRAs.

For many people, it is best to invest for the 401k match, then work toward maxing out your Roth IRA because of the long term tax benefits that Roth accounts offer.

Investing in both a Roth IRA and a 401k helps diversify your taxes in retirement years. Here are some more tips about maximizing your 401k plan contributions.

How You Can Contribute To An IRA

Each person can contribute up to $5,500 in an IRA and there are several ways you can max out an IRA if you choose to (or contribute any amount up to the max). Decreasing your 401k contributions is one way.

You can also use some of the $1,500 in cash savings you accumulate each month. If you want to make the contributions all at once, you can use a portion of your emergency fund to partially fund your IRA, then set up automatic investments to use dollar cost averaging to max out your IRA over the course of the year.

It would take $458.33/mo. per person ($916.66/mo. for both people) to max out an IRA with monthly contributions. You can repay your emergency fund over the next few months.

I don’t normally recommend people use their emergency funds to invest, but you can probably afford to do this as you and your husband both have stable jobs and your excess cash flow should make it relatively easy for you to build your emergency fund back up over just a couple months.

Vanguard Funds

Don’t let the $3000 minimum stop you from investing in the Vanguard Lifecycle funds if that is the plan you wish to invest in. You have a substantial emergency fund and stable jobs, so you could afford to invest the $3,000 or $6,000, then repay your emergency fund over the next couple months.

Alternatively, you could save each month until you reach the $3,000 required to open a fund. I don’t think making a $3,000 or $6,000 initial investment instead of making monthly installments will hurt you over the long run.

In fact, many studies show that lump sum investing outperforms dollar cost averaging in the long run. So making a large lump sum investment is actually a good idea.

Goal 2: Increase Cash Savings

Cash Savings

My wife and I just had our first child and we are in a similar position as you imagine you and your husband might find yourselves. We are looking at the need to upgrade on a vehicle in the next few months, and move out of our condo in the next year or so.

We started saving for this about 2 years ago, and we are glad we did – there will be a lot of unexpected expenses along the way! Starting early is the right way to go.

To meet your cash savings goals, try to determine what your needs might be: what size car, housing needs, stay at home mom or working mom, etc. It’s tough to answer these questions because the answers are unknown until you get there, so do the best you can, knowing that things may change in the future.

If it makes you feel better, err on the side of caution and save a little extra cash. You may also start looking for other methods of saving money so you can increase your monthly savings (eating out less often, dropping premium cable services, etc.).

These questions can help you determine your comfort level regarding how much cash you need to keep in your emergency fund.

How You Can Meet Both Financial Goals

Save For Retirement and Cash Goals

Your current salaries allow you to save $1,500 per month, which means you can continue your current 401k allotments, fully fund your IRA, and stick the remainder in your cash savings.

You may find it helpful to earmark your savings for specific goals so you can track progress as you save. For example, Capital One 360 offers sub-accounts, which makes it easy to direct your saving toward specific goals.

It’s OK For Your Goals and Situation to Change

If you ever feel the need to increase your cash savings, then you can decrease your 401k or IRA contributions, then direct the remaining amount toward cash savings.

Or you can contribute in any combination in between. Do whichever arrangement makes the most sense for your needs.

In the meantime, you can maintain higher cash flow if you remain in your current house and drive the same cars until you need to upgrade if you have children.

Remember, having a smaller home is more affordable than upgrading before you are ready or before you need it. Keeping your expenses lower now will give you more financial flexibility and help you better meet your financial goals.

Determine How Much Cash You Need, Then Invest the Rest

It’s good to keep some cash liquid. This is important for your emergency fund and paying for any short term needs. But if you want to make money, you need to invest it, not keep it in a savings account.

Even the best online savings accounts only offer a little over 1% interest. That’s fine for the money you might need quick access to (your emergency fund), but it won’t make you a millionaire or help you grow your wealth.

Where to Store Cash Savings

With savings and investment goals in mind, you need to determine the best place to put your funds. Let’s take a quick look at some of the best places to store your cash savings.

Online High-Yield Savings Accounts

While traditional savings accounts are a safe bet, you won’t be garnering the interest that you could with an online account.

Because online banks don’t have brick and mortar establishments to fund, their fees are lower and their interest rates are higher.

The top online high-interest savings accounts offer high returns, little to no fees, and functionality. Many of those accounts come with mobile banking features, alotted numbers of transfers, access to the banks’ ATMs, and customer support.

If you’re looking to safely store your savings without the risk that often accompanies investments but still get a solid return and easy access to your funds, a high-yield savings account is your top choice.

CDs

Certificates of deposit are another low-risk short term savings option which you might want to consider.

CDs come in terms, like 1, 2,3, or 5 years. The only catch with a CD is that your money has to stay there until the account reaches maturity at the end of its term.

The best places to open your next CD are typically online banks, but credit unions and traditional banks offer decent CD rates as well.

To make even more money with your certificates of deposit, I recommend a strategy of CD laddering.

Laddering your CDs allows you to access some of your money and earn a higher profit on interest. With a 5-year CD ladder, you invest in a 1, 2,3,4, and 5 year CD, meaning you’re never more than a year away from getting your hands on your savings.

Although CDs don’t have as high a potential return as other investments, if your main goal is safely stashing your funds, they’re a good option. CDs have a better return than a traditional cash savings account and allow you to dip your toes into strategic investment.

Money Market Account

A money market account gives you the best of both the checking and savings worlds.

Money markets, like CDs and high yield accounts, have better interest than traditional savings accounts, and you can access your funds when you need them. Most banks offer money market accounts, and you can even write some checks from those accounts.

In order to maintain high interest rates, money market accounts come with higher minimum balances than other savings accounts. They also invest in low-risk ventures like government securities and commercial paper.

Treasuries

You can’t get much safer in the investment world than purchasing a treasury bill or note.

If you want to accrue some interest on your savings without risking it all, you might consider a treasury.

Treasuries aren’t taxable on the local or state level, they’re backed by the full faith and credit of the United States government, and they come in the form of bills or notes. A note, for instances, is purchased at a term with a set interest amassing every six months.

A bill, on the other hand, is purchased at a discount, and you receive it at face value once it matures.

Where to Invest Retirement Savings

When it comes to retirement savings, the stakes are different than they are with short-term savings options.

Where you place your retirement savings depends on your goals and how comfortable you are with taking risks.

Types of Retirement Accounts

401 (k)

Most people start here, enrolling in a 401 (k) or 403 (b) account with their employer. If you change jobs, your account can be rolled over to your place of employment or your IRA.

Traditional IRA

If you’re under age 50, your Roth and IRA contributions are capped at $5500, and $6500 above age 50. A traditional IRA’s growth is tax-free.

Simple IRA

Simple IRAs are perfect for small companies with fewer than 100 employees. A simple IRA gives you the opportunity to contribute and be matched by your employer at a certain percentage.

SEP IRA

Ideal for self-employed individuals, simplified employer pension is easy to set up and allows you to contribute 25% of your income or $55,000, whichever is less.

Roth IRA

I’ve written extensively about Roth IRAs and where to open them. The Roth should be your next line of retirement investing after maxing out your 401k.

Roth IRA funds are pre-taxed and contributions can be accessed without penalty.

Retirement Investment Options

Within those types of accounts, you need to decide how your money is invested. Here are a few tips to keep in mind as you determine how much risk to take with your retirement investment portfolio.

If you’re young and have zero aversion to risk, consider a small-cap stock. They’re risky but the returns could be huge.

If you do your research and insert a few carefully chosen stocks to your portfolio, you could benefit greatly. You might also consider an option like an ETF or mutual fund investment.

The closer you get to retirement, the more you have to risk.

The more money you’re risking, the more caution you might want to apply to your investments. Bonds and blue-chip stocks are great options that are a little safer than small-cap stocks but still highly rewarding.

As you near retirement, take advantage of the increased contribution limit and put as much as you can into your retirement accounts.

With a diverse portfolio, measured risks, and defined goals, you can retire with ease.

More Thoughts on Cash Savings and Retirement Investing

Pinyo from Moolanomy.

Plonkee from plonkee.com.

Thanks for contacting us, Penelope. I hope these ideas give you and your husband a few more ideas to consider regarding your short term and long term goals.

You have plenty of options to choose from, so please be sure to decide which actions are best for your needs. You may also consider consulting with a financial planner for more information.

Best of luck!

Readers – do you have any suggestions?