Is Investing Riskier Than Saving?

We’ve all heard that investing in the stock market is risky and have encountered stories about people losing it all when investing poorly. People say that in order to keep your money safe, you should store it in the bank. That way you know it’ll be there when you need it. But is this really true? Is your money better off in a bank than invested in the stock market? And what does it mean for something to be risky?

Is Investing Riskier Than Saving? The Cozy Nest Egg Podcast

What is risk?

Before we can answer whether investing is riskier than saving, we first need to define risk. There are generally two different ways that risk is defined in finance.

1. Risk is volatility.

This is the definition of risk that a lot of finance professionals use when talking about investments. The more an investment’s value goes up and down, the riskier it is considered. For instance, cryptocurrencies often have high volatility, so they are considered a high risk investment. On the other hand, investments with a stable return, either up, down, or flat, are considered low risk because you have a fairly high confidence in how your investment will perform over a particular time frame.

2. Risk is the chance that you will lose money.

This is the definition of risk that I think is the most common among the general public. How likely is it that we will lose money by investing? If there is a high chance that we could lose money with a particular investment, then it is high risk. If there is a low chance, then it is low risk. If there is virtually no chance of our money decreasing, then the investment is usually considered risk-free.

How can we evaluate risk?

We can determine how risky it is to save or to invest by evaluating risk based on the two definitions above. And I know what you’re thinking: isn’t saving in a bank risk-free? Well, yes and no. Your money will not decrease, but your purchasing power might if the interest you receive is less than inflation. Inflation is when the cost of goods and services increases over time. You can read more about inflation here. It is important to keep inflation in mind when evaluating risk because you want to make sure that you are still able to afford the same things in the future that you can today. Even if the amount of money you have does not decrease, it can lose value over time.

Unfortunately, there is no way to know for sure what future returns will be for investments, what future interest rates will be for banks, or what future inflation levels will be. Instead, we are limited to relying on historical data. This data can give us a good sense of what the future might look like, but just keep in mind that there is no guarantee that the future will look like the past.

Investing data

For this article, I considered the return of the S&P 500, including dividend reinvestment, to be representative of investing. I gathered data from DQYDJ and analyzed annualized rolling returns of 1-, 2-, 3-, 5-, 10-, 15-, 20-, and 30-year periods to determine how returns varied depending on the time frame, with and without adjusting for inflation. This data stretches from 1871 to 2021, and I considered a year to be from January of one year to January of the next (there may be some variation depending on which month you use to start a period, for instance if that month is before or after a market crash).

Savings data

There is much less available data for bank savings account interest rates, so I instead referenced the Federal Funds Rate, which I found data on stretching back to 1928 through the Federal Reserve Bank of St. Louis. The Federal Funds Rate pretty closely matches the interest rate on a 3-month certificate of deposit (CD), which is a good approximation for short-term savings. The data for the CD’s annual percent yield (APY) was from the same source as the Federal Funds Rate.

3-month CD rates closely track the Federal Funds Rate

As with the S&P 500 data, I calculated annualized rolling returns of 1-, 2-, 3-, 5-, 10-, 15-, 20-, and 30-year periods for the Federal Funds Rate data and also analyzed these returns after adjusting for inflation, using inflation data from the Federal Reserve Bank of Minneapolis.

Data comparison – how to read box and whisker plots

To compare the data, I made use of box and whisker plots. In case you have not been exposed to them before, or if you could use a refresher, I thought it would be worthwhile to first explain the components of these plots to make it easier for you to follow along later. To that end, here is a labeled box and whisker plot of the 1-year rolling return for the S&P 500 index fund with dividends reinvested (not inflation-adjusted):

Labeled box and whisker plot of the 1-year rolling return of the S&P 500 index fund with dividends reinvested

As you can see, a box and whisker plot displays the full range of the data, calling attention to certain important features: the 25th percentile, the median (50% point), the mean (or average), and the 75th percentile. This allows you to see where most of the data lies and how it varies from the mean and median.

How does investing compare to saving without adjusting for inflation?

Let’s first start by examining typical returns for both investing and saving over the short term and over the long term. Here’s a graph of rolling returns for the S&P 500 index including dividend reinvestment for various time periods:

Annualized rolling return of the S&P 500 index, including dividend reinvestment, for various time periods

As you can see, the mean and median annualized return is fairly consistent across time periods at around 9-11% and 8-11%, respectively. However, the range of returns is quite broad in the short term and much more narrow as the time period gets longer, which we will discuss in a moment.

But first, here’s a graph of rolling returns for the Federal Funds Rate for the same time periods:

Annualized rolling return of the Federal Funds Rate for various time periods

The first thing you’ll notice on this graph is that the annualized return is never 0% or below. This makes sense because you wouldn’t expect to lose money on your savings. The mean and median return for saving is also relatively consistent, though it does increase a bit for longer time periods, ranging from about 3.8-4.8% and 2.7-4.8%, respectively. These returns are significantly lower than the investing returns, as you would expect, but they are also less volatile, particularly over the short term.

Let’s talk about that volatility and what that means in terms of risk.

Standard deviation of the annualized rolling return of the S&P 500 index, including dividend reinvestment, compared to the standard deviation of the annualized rolling return of the Federal Funds Rate for various time periods

As we mentioned before, investment returns are quite volatile in the short term, with a standard deviation (a measure of how variable returns are) of 18% for 1-year periods. This is high but unsurprising, considering that 1-year rolling returns ranged from -36% to 57%. As rolling periods get longer, investment returns quickly become much less volatile, falling to a standard deviation of 10% by 3 years, 5% by 10 years, 3% by 20 years, and 2% by 30 years. On the other hand, the standard deviation for returns on savings is fairly constant, decreasing slightly for longer periods from 3.7% down to 2.4%.

As you would expect, volatility for savings is much lower than for investing for short time periods, suggesting that it is less risky. However, the difference in volatility becomes much smaller by 10 years and is negligible by 20 and 30 years. In fact, the standard deviation for 30-year periods is actually slightly lower for investing than for saving. This suggests that over the long term, investing and saving are equally low risk.

However, what about the chance you’ll lose money by investing it? Here’s a graph showing the percent of periods where an investor would have received negative returns:

Percent of rolling periods with negative returns for the S&P 500 index, including dividend reinvestment, compared to the Federal Funds Rate for various time periods

As you can see, there is definitely a chance you can lose money in the short term by investing, whereas you will never lose money by saving. The chance of losing money in any one year is about 27%. However, like the volatility we discussed before, the chance of losing money by investing decreases rapidly as the time period gets longer. For 5-year periods, there was only a negative return 11% of the time, which decreased to 3% for 10-year periods. By 15 years and above, no rolling period yielded a negative return. This suggests that investing is riskier than saving over the short term, but, just like we saw from the volatility data, both investing and saving are equally low risk in the long term.

However, while future investment returns are only a guess based on historical data, we actually do know what the interest rate is for savings ahead of time, at least for the short term, and even when it changes in the future, we can always choose to do something else with our money if the interest rate offered is undesirable. This reduces the riskiness of saving because we have more control over what return we get on our money. However, if the interest rate is undesirable, this means the only option for a higher return is likely through a riskier avenue, which negates this benefit to some degree. There is also another variable which can greatly affect the value of our returns from both investing and saving and which we cannot know ahead of time with certainty even for saving: inflation.

How does inflation affect the comparison?

While the Federal Reserve has been attempting to keep inflation at about 2% per year over the long term, there can still be quite a bit of variability, and estimates of what inflation will be going forward on a month-to-month basis are not particularly accurate, as was the case for May and June of this year when inflation was higher than estimates. When inflation rises, your money loses purchasing power. That means you need more money to maintain the same standard of living you have today. To calculate what your returns would be in today’s dollars, you have to factor in inflation.

Here’s what investing returns look like when adjusted for inflation:

Annualized rolling return of the S&P 500 index, including dividend reinvestment, for various time periods, adjusted for inflation

While typical returns before inflation were around 8-11%, after inflation both mean and median returns are around 6.5-8.5%. Even with inflation, you can see that returns retain a fairly symmetrical distribution.

Interestingly, adjusting for inflation actually makes savings returns relatively symmetrical as well, as you can see below. (If you go back to check the graph without inflation, you’ll notice that returns are skewed towards the high end).

Annualized rolling return of the Federal Funds Rate for various time periods, adjusted for inflation

Like investment returns, savings returns are also lower after inflation. Instead of typical returns of 2.7-4.8% before inflation, mean returns after inflation range from 0.4-0.8%, and median returns range from 0.7-1.2%. This means saving is essentially just matching inflation. And you’ll notice that a big difference between before and after factoring in inflation is that a large portion of savings returns actually drop below 0%, which we’ll quantify shortly.

But first, here’s how the volatility looks when you adjust for inflation:

Standard deviation of the annualized rolling return of the S&P 500 index, including dividend reinvestment, compared to the standard deviation of the annualized rolling return of the Federal Funds Rate for various time periods, adjusted for inflation

For investing, volatility is not affected much by factoring in inflation. For saving, adjusting for inflation actually reduces standard deviation a bit across the board. This means that saving is even less risky in terms of volatility when taking inflation into account.

And finally, on to the big impact of inflation, how it affects your chance of losing money:

Percent of rolling periods with negative returns for the S&P 500 index, including dividend reinvestment, compared to the Federal Funds Rate for various time periods, adjusted for inflation

You can see the big change here right away. While the chance of losing money by saving was always 0% without inflation, once you adjust for inflation, the chance of losing purchasing power rises all the way to 30-40%! The chance of negative returns also increases for investing after adjusting for inflation, but not nearly as much as for saving. In fact, there were no 20- or 30-year periods with negative returns for investing. Even for short periods, investing had a lower chance of negative returns than saving. Interestingly, while the chance of losing money decreases consistently as the time period increases for investing, the chance of losing purchasing power for saving actually increases as the time period expands from 1 year to 2, 3, and 5 years before decreasing slightly. Even for 30-year periods, the chance of losing purchasing power through saving remains above 30%. This suggests that investing may actually be less risky than saving in both the short term and the long term after adjusting for inflation.

So is investing riskier than saving?

It’s complicated. If you don’t care about the effects of inflation, then investing is riskier than saving over the short term (less than 15 years) both in terms of volatility and the chance of losing money. Over the long term (15 years or more), risk is about the same for both investing and saving. Over this longer time frame, standard deviation of returns for both is less than 5% and the chance of losing money (as far as you can rely on historical returns) is 0%. The big difference between the two, then, is not risk, but rather returns. Over periods of 15-30 years, investing yields typical returns of 8-10%, while saving yields typical returns of 3.8-4.8%. This suggests that even risk-averse individuals with a long time horizon would be better served investing rather than saving. However, for short-term periods, saving is safer.

If you do care about inflation (which you should since it determines how much your money is actually worth), then whether investing or saving is riskier depends on how you define risk. If you consider risk to be volatility, then saving is less risky than investing up to time periods of about 20-30 years, when their risk is about equal. If you consider risk to be your chance of losing money (or in this case losing purchasing power or the value of your money), then investing is far less risky than saving for all time periods. Essentially, any time you save money in the bank, there is a 30-40% chance you will lose out to inflation. If you’re investing instead, that chance is much lower, never exceeding 30% even for a single year. By 5 years, it’s under 20%; by 15 years, under 5%; and by 20 years, there a 0% chance of losing money. Again, this is only based on historical data, so the future could be different; but regardless, this suggests that investing is much less risky than saving in terms of maintaining and growing your money above the rate of inflation, particularly over the long term.

Now, I should note that this is only true if you’re investing in an index like the S&P 500 or a broad market index. Investing in individual stocks is much riskier. In fact, a J.P. Morgan study found that from 1980 to 2014, about 40% of all stocks fell 70%+ from their peak and never recovered. Over that same period, the S&P 500 had an annualized return of 11.6% per year with dividends reinvested. If you’re looking for the most low-risk way to grow your money above the rate of inflation for the long term, investing in an index like the S&P 500 is your best choice, even better than saving in a bank.

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