Generally, the decision to “save” or to “invest” is based on whether the goal is short-term or long-term. Money for an emergency fund or short-term purchases is usually put into the safest products that allow quick access at any time. Examples include checking accounts, saving accounts, money market saving accounts (not the same as money market funds) and certificates of deposit (CDs). At some banks and savings and loan associations deposits may be insured by the Federal Deposit Insurance Corporation (FDIC). But the tradeoff for security and ready availability is a very low interest.
Interest is the cost of using money. When you put money into a savings account the bank pays you interest. Interest is usually given as an annual percentage rate (APR) — the amount your money would earn if left in the account for one year.
Any money you have in checking and savings accounts and in certificates of deposit is known as a deposit. Your financial institution is committed to returning all of your deposits (plus interest) whenever you ask. You can even take money out of a CD before it matures, however, you will have to pay a penalty for early withdrawal. Your institution is also required to carry government insurance on your deposits up to $250,000. The insurer is usually the Federal Deposit Insurance Corporation (FDIC). Contact your financial institution if you have specific questions about your insured deposits.
An investment is the use of money (capital) to create more money. Money for long-term goals can be invested in stocks, bonds, annuities and mutual funds. When you invest there is a greater chance of losing your money than when you save. On the other hand, investing provides the opportunity to earn more money than saving in a deposit account. Unlike FDIC-insured deposits, money invested in securities, mutual funds, and other similar investments are not federally insured. The amount invested (principal) can be lost. That’s true even if you purchase your investments through a bank.
Financial institutions can also provide investment products like mutual funds and annuities to their customers. Your bank or credit union may sell you this type of product, but it is not obligated to pay you back for any losses you may have if the investment is not successful.
Equally important, the U.S. government does not insure you against investment losses, even if you purchased the product at a bank or credit union.
Investing in a Mutual Fund
When you invest in a mutual fund, your money is put together with the money of other investors and is used to purchase a variety of securities such as stocks, bonds, and other financial instruments.
Mutual funds are run by investment professionals who decide which investments to buy or sell for the fund. Their decisions are guided by the fund’s investment goals. For example, some mutual funds are designed for people who want to have easy access to their money and invest only for a short time. These funds invest primarily in government securities or very short-term bank CDs, where the investment risks are moderate.
Other mutual funds appeal to people who are willing to take on more risk with the goal of a higher return. Such funds invest primarily in corporate or municipal bonds. Most mutual funds, however, are more diverse, offering a mix of investments. A typical fund portfolio includes between 30 and 300 different stocks, bonds, and other instruments.
Investing in an Annuity
When you buy an annuity, the bank or insurance company invests your money and agrees to pay you back according to the annuity’s contract terms. The annuity can be part of a long-term savings plan for retirement. Like mutual funds, they are not insured by the U.S. government or by the bank where you buy them.
Some annuities help you set aside money on a tax-deferred basis. You don’t pay taxes on the income earned by this money until you retire. Other annuities allow you to receive income immediately. However, the amount of income you will receive can go up or down with changes in financial markets and the income won’t be tax deferred.
With annuities, the annuity contract spells out the terms of your agreement. It will tell you whether or not you can transfer your contract to another company. Also, surrender charges or penalties apply when funds are withdrawn before a designated period of time has passed. Surrender charges can apply from five to ten years or more. You may want to consider meeting with a qualified tax advisor or financial planner to learn more about annuities.
Buying Through Your Institution
Not all banks and credit unions sell investment products, but many do. Some simply rent lobby space to outside companies. Other institutions sell what are called proprietary funds, which are sponsored by an outside company but receive investment advice from the institution itself. Private label funds, meanwhile, are sponsored and managed through an outside company but are only sold through one bank or credit union.
Some mutual funds and annuities have names that sound very much like names of financial institutions. But no mutual funds or annuities are insured by either your institution or the U.S. government. As an investor, you should be aware that these funds have different degrees of risk and could possibly lead to a loss of some or your entire principal.
New Deposit Insurance Limits—The standard insurance amount of $250,000 per depositor is in effect through December 31, 2013. On January 1, 2014, the standard insurance amount will return to $100,000 per depositor for all account categories except IRAs and other certain retirement accounts, which will remain at $250,000 per depositor.
Source: Federal Deposit Insurance Corporation