A bank is a nice security blanket: It keeps your money safe, accessible and insured, ready to pay regular bills or cover an unexpected expense.
But the warmth and fuzziness can wear off quickly when you realize low interest rates on bank accounts are holding your money back. Once you have your bill-paying funds and emergency savings covered, look at alternatives such as investments that can grow the rest of your money faster.
Here’s how to know when to pivot from bank accounts to other savings options.
Set up your safety net …
Your emergency fund needs a foolproof plan and a security guard, and the Federal Deposit Insurance Corp. provides that for many bank accounts. The FDIC insures banks, so consumers’ deposits are protected if a bank fails. But the highest rates you’ll get on savings accounts range between 1% and 2%, compared with potential average annual returns of up to 7% on investments.
»MORE: How to switch banks
Keep only what you need for bills and emergencies in a bank. For checking accounts, the minimum balance plus a $500 cushion for unforeseen expenses should be left after you pay bills. For your emergency fund, save three to six months of income, more if you’re self-employed. Once you reach these goals, take your extra money elsewhere.
»MORE: Compound interest calculator
… Then build a portfolio
With your money for expenses and emergencies safe in a bank, it’s time to consider long-term options that can offer better returns. Compound interest — the interest you earn on prior interest — adds up over time. The sooner you get started, the more you can earn. Here’s how to start building your investment portfolio.
- Pay off high-interest debt: If you have credit cards with interest rates approaching 20%, for example, paying them off will give you an immediate return by avoiding or reducing those interest payments.
- Save for retirement: Contribute to your 401(k). If you’re still paying off debt, contribute just enough to get the employer match, and continue your payoff plan. Once you’re caught up, put additional savings in an IRA or a Roth IRA. Aim to save between 10% and 15% of your gross income to stay on track for retirement.
- Open a brokerage account: This is a good option if you’ve maxed out contributions to your retirement fund or you want to save for other long-term goals, such as a dream vacation or your daughter’s wedding. Depending on the broker, you can buy and sell stocks, bonds, mutual funds, currency, futures and options contracts.
With investments you can earn more, but you can also lose more because your money isn’t insured like it is at most banks. Diversify your portfolio by putting your money into investments that vary across countries, industries, asset classes or company size. A well-balanced portfolio can minimize risk.
Your goals and age will determine the best options among short-term or long-term investments, and you’ll adjust as you get older. For example, as you approach retirement you may want to minimize risk by increasing the proportion of bonds in your portfolio and decreasing your allocation toward stocks.
Weigh the options and choose the plan that best suits your financial goals.
This article was written by NerdWallet and was originally published by USA Today.