19 Aug Where should young adult invest her savings for higher returns?
Q. My college student daughter just turned 21 and is interested in learning how to invest some of her savings to make more than 1% on a bank savings account. Any suggestions on where to start with $1,000?
A. Your daughter is smart to be thinking about saving now at a young age. That will allow her to harness the power of compounding over the coming decades.
She’s also smart to be dissatisfied with the rates paid on many bank savings accounts, which currently can run as low as 0.01%, said Gene McGovern, a certified financial planner with McGovern Financial Advisors in Westfield.
He said with the Consumer Price Index increasing 1% over the last 12 months, the rate of inflation is 100 times more than many savings account interest rates.
For example, he said, $1,000 invested in a bank savings account paying 0.01% would pay just 10 cents per year in interest. That same $1,000 invested at 1 percent would pay $10.
McGovern said where to invest her savings depends in part on some other aspects of your daughter’s financial situation, such as whether you are currently supporting her, whether she has an emergency fund and whether she will need that $1,000 within the next few years.
“If your daughter has short-term needs for the money, such as an emergency fund, it should be invested in safe, short-term, liquid investments, such as bank or credit union savings and money market accounts, money market funds, Treasury bills, or short-term certificates of deposit,” he said. “Given the low rates paid by most of those options, one of the best current vehicles is FDIC-insured online bank savings accounts, many of which are paying just over 1% interest. Many have no minimum deposit or very small ones.”
These accounts may at least keep pace with inflation while providing significantly better returns than those available from most brick-and-mortar banks, McGovern said. Simply Google “best online savings accounts” to find the best rates.
On the other hand, if your daughter won’t need the money within the next few years and wants to invest long-term, an excellent option is a target date retirement fund, such as those available from Vanguard, Fidelity, Schwab and many other investment companies, McGovern said.
“Target date funds generally invest in other mutual funds or exchange-traded funds within the same fund family. The later the date, the higher the initial allocation to stocks,” he said. “For example, a target date 2060 or 2065 fund, which would likely be appropriate for your daughter, generally invests about 90% in stocks — both domestic and international — and 10% in bonds as of 2020.”
The funds automatically rebalance and gradually grow more conservative over time by increasing the allocation to bonds and decreasing the allocation to stocks, he said. Some have no minimum investment, while others may have a $1,000 minimum.
McGovern said the appeal of these funds, especially the indexed versions, is that they are very widely diversified, which lowers their risk, while having relatively low expense ratios. They provide an excellent introduction to investing by offering a professionally researched, constructed and managed portfolio.
“Note that a 90% allocation to stocks is aggressive and may not be suitable for investors with a lower risk tolerance, even those with a long time horizon,” he said. “If your daughter wants to start out more conservatively, she could simply pick an earlier target date fund or a traditional balanced fund or exchange-traded fund that offers a 60/40 allocation between stocks and bonds.”
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This story was originally published on Aug. 19, 2020.
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