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Investing is a healthy part of money management. It can be an instrumental way to build wealth, retire comfortably and help you reach any other financial goals faster. But when it comes to goals that are in the very near future — like one year or less away — you might want to reconsider investing that money.
According to Priya Malani, the Founder and CEO of Stash Wealth, you should avoid investing your money if you'll need it in one year.
"Almost everything outside of savings accounts, money market accounts, treasury bills and certificates of deposit has risk," she explained. "Stocks, mutual funds, bonds and real estate all contain various levels of risk. Risk doesn't mean it's bad but you don't want to take on risk unless you have time to ride out the ups and downs."
Time is one of the most important elements of investing. The longer you stay invested, the more your money can grow, and one year just isn't long enough to maximize your money's growth. In fact, we had a financial planner crunch the numbers to help us figure out how much money 30-year-olds should invest each month in order to become a millionaire if they stayed invested for 35 years — they'd need to invest just $370 per month in an aggressive portfolio (assuming a 9% return) to become a millionaire over such a long time horizon.
"With the luxury of time, you can have the patience to ride out an investment that's losing money until it's making you money," Malani said. "Just because an investment is losing money today, doesn't mean it will do so forever."
Instead of investing your money, Malani recommends keeping your money in a high-yield savings account if you're going to need your cash in one year.
High-yield savings accounts stand out from traditional savings accounts in that they reward you with a higher interest rate, allowing your money to grow even faster as it sits in your account — even when you don't actually make additional contributions. Sure, you won't earn hundreds of dollars in interest each month but it's a lot better than the pennies in interest you're getting through a traditional savings account.
And, when you keep money in a high-yield savings account, you won't have to worry about needing to make a withdrawal during a dip in the market when you might potentially lose money. There are many different high-yield savings accounts out there but Select named the Marcus by Goldman Sachs High Yield Online Savings as the best overall account and the Vio Bank High Yield Online Savings Account as the best account for earning a higher interest rate on your balance.
Another consequence of investing short-term money is the tax bill that will inevitably follow after you sell the asset you were invested in. Selling a stock or mutual fund triggers what's known as a taxable event and the amount of tax money you'll owe will depend on how long you held onto that particular asset.
If you sell an asset more than one year after purchasing it, you will pay long-term capital gains taxes, the rate for which will be 0%, 15% or 20%, depending on your taxable income or filing status. For most people, though, the long-term capital gains tax rate is lower than their ordinary income tax rate.
However, if you sell an asset less than one year after purchasing it, you will pay short-term capital gains taxes, which is equivalent to your ordinary income tax rate. Depending on your tax bracket, this could mean having to pay a much higher tax rate, up to 37%. When investing your money, it's often prudent to make sure you won't need to sell your investment within a year so it has more time to grow and to save on your tax bill.
While it may be tempting to invest your cash to make it grow faster for your short-term goals, it's generally a risky move since you won't be giving yourself enough time to wait out any huge dips (and potential losses) in the market. And with a looming tax bill every time you sell off an investment, it's better to just keep the money in a high-yield savings account if you'll need it in one year.
Information about the Vio Bank High Yield Online Savings Account and Marcus by Goldman Sachs High Yield Online Savings has been collected independently by Select and has not been reviewed or provided by the bank prior to publication. Vio Bank is a division of MidFirst Bank, Member FDIC.