High-yield savings account vs. investing: Which is right for you?
Knowing where to put your money is crucial to ensuring you reach your financial goals. High-yield savings accounts can help keep your money safe for short-term financial goals and needs while investing creates opportunities to achieve long-term goals and build wealth.
If you're considering a high-yield savings account vs. investing, consider using both to find a good balance in your financial plan.
What is a high-yield savings account?
A high-yield savings account functions similarly to a traditional savings account, except that the interest rate is much higher. In some cases, you can get an annual percentage yield (APY) that's 10 times higher than the national average savings account rate.
High-yield savings accounts typically have no minimum balance requirement or monthly fee, though some banks may require you to meet a certain minimum balance to earn interest or avoid a monthly service charge.
Depending on the financial institution, you may earn the same rate regardless of your balance, or your APY may be tiered based on your balance. The interest you earn is typically taxable.
A high-yield savings account is safe — there's no way for your balance to go down unless you take money out — making it a great option for short-term financial goals, such as an emergency savings fund, home down payment, or vacation.
What is investing?
Investing involves trading certain financial assets and instruments to generate a return on your money. The most common ways to invest include a retirement account, such as a 401(k) or an individual retirement account, or a traditional brokerage account.
Assets you can invest in include stocks, bonds, mutual funds, exchange-traded funds (ETFs), real estate, and many more. Because many investments experience more volatility in the short term, investing your money is generally best for long-term goals, such as retirement or educational planning. You may also consider investing once you've reached your short-term savings goals with other savings tools.
Unlike with high-yield savings accounts, though, investing can be risky, and you can lose some or even all of your principal investment. There are strategies you can employ to limit your exposure to risk, such as diversifying your portfolio, but there's no way to avoid risk entirely. With greater risk, however, you also have the potential to earn a higher return on your money.
Gains on investments are typically taxable, but only when you sell your investments and realize the gain.
Differences between high-yield savings accounts and investing
Understanding the difference between putting your money in a high-yield savings account vs. investing it can give you a better idea of the right option for you. Here's what to consider.
Returns and potential gains
Even the highest high-yield savings account rates are generally not enough to outpace inflation, making them less appealing for long-term financial objectives.
In contrast, you can earn relatively high returns with an investment portfolio — though your actual performance can vary depending on how you invest your money and market conditions. Again, the greater the risk of the investment, the greater the return potential.
Risks and volatility
High-yield savings accounts are considered to be risk-free. Even if your bank fails, insurance coverage from the Federal Deposit Insurance Corp. (FDIC) — or the National Credit Union Administration (NCUA) for credit unions — protects up to $250,000 per account, per owner. While interest rates on savings accounts can fluctuate over time, they don't go negative.
On the flip side, some investments can be incredibly volatile in the short term, which means that your previous gains and even your principal balance can be at risk. Over the long term, however, many investments tend to go up in value.
If your broker is a member of the Securities Investor Protection Corp. (SIPC), your money in an investment account is protected up to $500,000, $250,000 of which is for cash only.
Liquidity and accessibility
Funds held in a savings account can be easily accessible via a transfer to a checking account or in some cases an ATM card. With investments, liquidity can vary. In a retirement account, for instance, you typically can't withdraw funds without incurring taxes and a penalty unless you've reached a certain age.
Even in a standard brokerage account, you'll need to sell off your investments, and it can take a few days for those transactions to settle before you can withdraw money.
If you need quick and easy access to your money, a high-yield savings account may be the right fit. But if liquidity and accessibility aren't top priorities, an investment account may be a good option.
Taxes and fees
Interest earned in a high-yield savings account is taxed at your ordinary income tax rate. When you sell an investment and realize a gain, however, you may qualify for the lower capital gains tax rate if you held the investment for at least a year before you sold it.
For investments sold within a year of the initial transaction date, you'll typically need to pay your ordinary income tax rate.
In terms of fees, high-yield savings accounts typically don't charge monthly fees, though some do. You may incur an excessive-withdrawal fee if you exceed your financial institution's monthly withdrawal limits.
It's easy to find brokers that don't charge trading fees, but you may still run into fees if you invest your money in mutual funds or ETFs or if you have a robo-advisor or financial advisor manage your money for you.
Pros and cons: high-yield savings accounts vs. investing
As with any financial product or activity, high-yield savings accounts and investing have both advantages and disadvantages to consider.
Pros of high-yield savings accounts
Interest rates aren't tied to market fluctuations
Rates are typically higher than traditional savings accounts
You won't lose your principal balance
Funds are liquid and easily accessible
Cons of high-yield savings accounts
Interest rates can rise or fall over time
Rates typically aren't high enough to beat inflation
Withdrawals may be restricted on a monthly basis
Interest is taxed at your ordinary income tax rate
Pros of investing
You can earn a higher return compared to a savings account
It makes it possible to build wealth in the long term
It doesn't require a lot of money to get started
You can control your exposure to risk through diversification
Cons of investing
It's possible to lose gains and your original investment
Liquidity can vary depending on the investment
Returns are tied to market conditions and can be volatile in the short term
It can take time and effort to build an effective portfolio
High-yield savings account vs. investing: Which option is right for you?
Ultimately, the choice between a high-yield savings account and investing depends on your financial needs and goals. In most cases, it makes sense to use both to establish a strong financial plan for the short and the long term.
With a high-yield savings account, you can save for short-term goals and emergency expenses, both of which can benefit from the lack of risk associated with bank accounts. But if you want to build wealth for the future, investing has the potential to give you better returns in the long run.
If you're considering which option is best for you, evaluate your current situation and what you want to accomplish with your financial plan. Then, determine how much of your income you want to allocate toward short-term savings and how much you want to invest toward long-term goals.
In some cases, it may make sense to consult with a financial advisor and get personalized guidance on how to proceed.