Savings as Sound Investment Strategy

Your savings account is flush, and you're in the habit of saving money regularly. If you're in that boat, good for you--and you might be thinking about taking it to the next level with some personal investing.

Personal investing can be an intimidating prospect. We think of investors as Wall Street executives and middle-aged millionaires who day-trade. It can be hard to see yourself in those shoes (unless you're a Wall Street executive). The investment world is rich in confusing terms and numbers that can put off would-be investors.

Investing doesn't have to be scary. Once you've learned some simple strategies, it can be as simple and rewarding as stashing every extra cent into your savings account. Personal finance writer J.D. Roth says in his excellent book, Your Money: The Missing Manual:

People tend to think that the more complicated something is, the better it must be, especially when it comes to finances. But that just isn't the case. In fact, the opposite is often true.

You want to begin investing from a solid financial base, so that upheavals in financial markets won't affect your financial equilibrium.

Moving Into Investments: How to Know When You're Ready

You're ready to start investing when you have a cash emergency fund safely stashed away in a savings account and aren't carrying consumer debt such as credit card debt. Personal finance guru Dave Ramsey says the time to invest your money is when you have no debt payments other than your mortgage and have 6 months of living expenses in a high-interest savings account.

If you're at that stage in your financial journey, you probably didn't get there by accident. Odds are good that you have solid savings habits already, and a frugal lifestyle.

What you need now is to put your money to work. That means investing your money in something riskier, but with the potential to give you higher returns, than a savings account. This is the ultimate tradeoff with investment risk: over the long haul, savings accounts pay an interest rate roughly equal to inflation, so your purchasing power remains the same through many years. With FDIC insurance, you won't lose money keeping your cash in one of these savings accounts, but you'll never get double-digit returns, either--even from the best savings accounts.

Long-Term Investing and Risk Tolerance

If you're just starting out in investing--and particularly if you have years before retirement or other milestone goal--you should take a long-term view. Day to day, the stock market is volatile. Over time, it gives investors a better return on their money.

But here's the catch: you have to be very certain that you can sustain the hit if the value of your investments goes down, maybe for years. If you're close to retirement, a home purchase in the next few years, or other near-term goal, you may decide to shun the market and stick with slow-but-steady savings accounts.

Diversification Wins the Day

To insulate your wealth from the ups and downs of the stock market, you want to mix up your investments a bit. One rule of thumb is to that the percentage of your portfolio that's kept in safer investments like AAA-rated bonds or US Treasuries should equal your age. So if you're 45 years old, you might choose to put 45% of your investment money into bonds. The rest would go to purchasing stocks.

Other Investment Tips

A good starting point for investing is your workplace. If you work for a large company, they probably offer matching funds for a tax-advantaged retirement plan, like a 401(k). An employer match for retirement contributions is like free money: you'll instantly get a 100% return on any funds that are matched. Company retirement funds may have pretty limited options for investment, but that's OK. You want to keep things simple.

If you're not the type to enjoy picking specific stocks or you want to maximize diversification, look for a simple, low-cost mutual fund, which is like a bucket of many stocks. Actively managed mutual funds--especially those with name-brand money managers--usually have higher fees, so those funds have to drastically out-earn a broad market index fund (like an S&P 500 fund that's more or less on autopilot) to make up for their additional costs. Many people will do better investing in a low-cost index fund that keeps their costs down and aims to match the market, not beat it.

As with any wealth-building strategy, the most important key is just to do it. Set up a regular schedule of investments and stick to it, just as you've done with your regular deposits to your savings account. You might see your stocks soar or crash from month to month or even from year to year, but over time a slow, simple strategy can pay big rewards.