Author Topic: Passive Index funds vs Saving Accounts  (Read 3791 times)

Sebster10

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Passive Index funds vs Saving Accounts
« on: September 20, 2016, 08:41:11 AM »
Hi everyone,

I'm somewhat a recent convert  to Mustachisim, and in my early twenties living in the UK with a few thousand pounds of disposable cash looking to put that money to work.

From reading MMM's blog, I know that he advocates passive index investing and I understand the argument for passive over actively managed funds. What I don't understand is why you would want to invest considering the expected long term return of 7% (I assume this is correct from reading MMM).

I am struggling to justify investing into a passive index fund when I can currently gain zero risk returns of 6% from government backed savings account such as this one http://www1.firstdirect.com/1/2/savings/regular-savings-account.

Or slightly riskier returns of 14% for investing with services such as https://www.ratesetter.com/ (4% return plus 100 sign on bonus when investing 1000).

I understand that these options are less feasible for someone with much higher amounts to invest and also require more effort but still an expected return of 7% seems low considering other options. I feel as though I am missing something here and any comments would be greatly appreciated!

Thanks!

robartsd

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Re: Passive Index funds vs Saving Accounts
« Reply #1 on: September 20, 2016, 08:58:24 AM »
You're right that chasing teaser rates and sign up bonuses can net significantly more return on small sums of money than passive index fund investing, but it does not scale and is not sustainable. The rates you indicate are only applicable to limited amounts of money and for a limited time. Go ahead and play this game if you like, for as long as you like; but eventually you'll want to put your money into long-term investing and low cost, passive, index funds are the best vehicle for that for most investors. Some people even continue to play the teaser rate/sign up bonus game with their emergency funds and/or short term savings while investing the bulk of their money in index funds.

Heckler

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Re: Passive Index funds vs Saving Accounts
« Reply #2 on: September 20, 2016, 09:55:42 AM »
In Canada, interest from a cash savings account is taxable as income.  So take off a good chunk of the interest at tax time.

Scandium

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Re: Passive Index funds vs Saving Accounts
« Reply #3 on: September 20, 2016, 10:27:58 AM »
ehh, the firstdirect 6% account is up to maximum of 3,600 per year, for one year. I put more than that into my 401k in 4 months! And intent to do it for decades. Not even "higher amounts", it's not in the same league. Tell me way to get this return on even  $10,000 or $50k outside the stock market? Heck, a 0.1% market move I earn (or loose..) more than you can in a year with that account.

RWD

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Re: Passive Index funds vs Saving Accounts
« Reply #4 on: September 20, 2016, 10:34:53 AM »
The 7% expected return is after inflation. So you're actually looking at 9-10% annual return if you want an accurate comparison. I'm not sure how it works in the United Kingdom, but here in the United States the tax rate on a savings account is worse than on index funds.

The savings account you linked to has several restrictions. The biggest one is a contribution limit of only 300 per month. It also appears to only work for one year. I don't see any reason why you shouldn't do this, but you'll probably find yourself with a lot of money leftover that still needs to be invested somewhere.

robartsd

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Re: Passive Index funds vs Saving Accounts
« Reply #5 on: September 20, 2016, 11:09:20 AM »
I'm not sure how it works in the United Kingdom, but here in the United States the tax rate on a savings account is worse than on index funds.
While this is generally true, it is not always true. Index funds can generate short-term capital gains and not qualifying dividends which are treated exactly the same as savings account interest. Also, an individual could buy and sell the index fund within a year triggering all gains receiving this tax treatment.

Classical_Liberal

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Re: Passive Index funds vs Saving Accounts
« Reply #6 on: September 20, 2016, 11:32:53 AM »
You're right that chasing teaser rates and sign up bonuses can net significantly more return on small sums of money than passive index fund investing, but it does not scale and is not sustainable. The rates you indicate are only applicable to limited amounts of money and for a limited time. Go ahead and play this game if you like, for as long as you like; but eventually you'll want to put your money into long-term investing and low cost, passive, index funds are the best vehicle for that for most investors. Some people even continue to play the teaser rate/sign up bonus game with their emergency funds and/or short term savings while investing the bulk of their money in index funds.

Voted "Best Answer", by me

Sebster10

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Re: Passive Index funds vs Saving Accounts
« Reply #7 on: September 20, 2016, 12:09:08 PM »
Thanks everyone, really helpful!

The 7% expected return is after inflation. So you're actually looking at 9-10% annual return if you want an accurate comparison. I'm not sure how it works in the United Kingdom, but here in the United States the tax rate on a savings account is worse than on index funds.

The savings account you linked to has several restrictions. The biggest one is a contribution limit of only 300 per month. It also appears to only work for one year. I don't see any reason why you shouldn't do this, but you'll probably find yourself with a lot of money leftover that still needs to be invested somewhere.

I completely missed that the 7% was after inflation, thank you for pointing that out! My spread sheet has now had a major update!

robartsd

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Re: Passive Index funds vs Saving Accounts
« Reply #8 on: September 20, 2016, 12:38:46 PM »
I completely missed that the 7% was after inflation, thank you for pointing that out! My spread sheet has now had a major update!
I think 7% after inflation is a bit optimistic (of course that's why we use the 4% rule for retirement planning). VTSAX 10 year yeild is currently showing as 7.75%. Inflation over the same period was about 1.85%, so recent history only provided a little less than 6% after inflation.

DrF

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Re: Passive Index funds vs Saving Accounts
« Reply #9 on: September 20, 2016, 12:42:57 PM »
Here's some good stuff from Interest Compound about investing your emergency fund.

Why does my emergency fund need to be in VTSAX?

Also, Interest Compound (and likely others) have been posting about the stupidity of keeping an emergency fund in cash. Basically, it never pays to keep cash as the returns you receive through investing will always provide extra cushion.
http://forum.mrmoneymustache.com/investor-alley/good-investment-for-emergency-fund-money/msg1064090/#msg1064090

more here:
http://forum.mrmoneymustache.com/investor-alley/where-to-keep-emergency-funds/msg1053087/#msg1053087