Bank vs Fund!

If you do choose to save your money in a bank account instead of mutual funds, you will miss out on tens of thousands of dollars over time. In this article I will bring you the math that will surprise many.

This article is a follow up to my last article about giving monetary gifts to children. Can be read here;

To sum up the above article I said I would save in a mutual fund for my children until they where 25 years old. Here is why I did not go for the good old traditional bank savings. Historic measures on mutual funds made me believe that my sons are better of with me buying them some mutual funds.

Let us have a closer look into the above statements. Here are some figures; you have some money that you want to save, either to save for your own pension or to help your kids establishing a great future – which is my case. Of course, it could be some difficulties to get oriented in the marketplace:

What pays off and what does not pay off? What is safe and what is associated with risk?

You know, the sad fact is that if you put money on the good old piggy bank, the value drops accordingly. If you place the money in a savings account in a bank, the sum of the price increase and the tax you must pay on interest will eat up more than the profit. Thus, this calculation will also be on the negative side. Not many people out there are aware of this - it is scary. That is a bit of the reason why I have chosen to get acquainted with this and write about it here.

I believe if you have a long-term savings goal, like saving up for the kids, it is equity funds that apply. From time to time, the stock market will fall. But since this form of saving is precisely long-term, one will over time be able to outperform bank savings of around 3-6 percentage points. Saving in funds can give children and young people opportunities that the older generation themselves never got, such as saving for studies, driver's licenses, cars, and equity for when you buy a home, which are all-natural things to save for.

While bank savings, as we understand, are safe, there is always a certain risk involved in having the money in funds. But, the degree of risk is up to you. The lower the risk you want, the more limited the return is usually - and vice versa: The more risk you are willing to take, the greater the possible gain. This is at least what I learned from my master’s degree in economics 😉

I assume that serious fund managers take care of clients' savings with the utmost seriousness. I reckon that they work based on a model that will not deal with speculation but to make investments in solid companies that create value and provide dividends over time. Everything else would have been, in my opinion, speculation and then I would most likely have had a different view of bank savings vs funds savings!

However, Today's deposit rate is almost historically low - and rarely rises to more than just over 1 %. Precisely this has led many to choose other ways and look for alternatives. Last I checked roughly 40 percent invest in funds in the western world. This is the highest that has been registered since the mutual funds' association started the measurements 20 years ago. Most people save to contribute financially to children. I have calculated the difference between bank- and fund savings based on a affordable sum every month. So, let's get acquainted with my son Erik, and follow him from birth and a good distance into life:

My son Erik is a child born just before COVID-19: conceived just before the world shut down in March 2020. At the same time as my partner and I enjoyed the birth and how it was to have children, we also reflected on the importance of contributing to the new world citizen making sure they have a secure economy. We choose to contribute with $1000 from each of us as a gift when Erik was born, and after that $100 each month. BUT, my partner and I have different strategies: I choose to save in mutual funds, while my partner chooses to save in a bank. Respectively, the future expected return is 5.75 % and 2.5 %, which is in line with historical returns. We also add $1000 each to his account when he turn 15.

If we were to give Erik the savings now (15 years old), the amounts are as follows:

My partner with her bank savings would be around: $23 000. Me with my mutual fund would be around: $31 000. And this distance will only increase…

But, this is not the end… we have further plans for Erik’s savings: We continue the monthly savings for another three years, until Erik is 18 years old. When Erik turns 18, the balance will show the following:

The money in the bank account has increased to $29 000. The mutual fund has increased to $40 500.

After 18 years with a relatively modest monthly savings amount, the difference has thus become $11 500. And the longer it takes before the money is withdrawn, the larger the gap between the two amounts.

However, let's get to the point! Our goal is to give Erik a solid financial hand when he enters the housing market, and therefore we save for him until he turns 25 years old. Then the difference has become as much as $27 500:

Banks: $43 500 Mutual funds: $71 000

This shows the importance of having money “working” for you over a longer period. And it shows the power behind compound interest.

Before we say goodbye to my son Erik, we follow him a bit further in life: Let us say that at the age of 25 he has saved up enough money to be able to finance his apartment on his own. Furthermore, he leaves the money he received from us in the mutual fund. The only difference now is that the monthly contributions of $100 from us will not take place.

How will the $71 000 from the mutual fund and the $43 500 from the bank account develop until Erik turns 65 years old?

The answer is…

The bank account will have grown to around $120 000. And the… mutual fund… wait for it… will have grown to $705 000!!!

The excess return by saving in mutual funds will then be almost $600 000 - money that will be able to ensure Erik a safe retirement (financially), and this is only with a little help from his parents.

What is your choice, regardless of whether you have children or not?... …the answer above depends on how much risk you are willing to take! 😊

Cheers -Olebulls

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