Two common methods of putting your money to work involve either saving your money in an interest-bearing account at a bank or investing your money in a company stock, where it can grow and perhaps earn dividends. Both methods have their own particular risks and rewards.
Bank Deposit Safety
The less risk you are willing to take with your money, the lower the rate of return you can expect to earn. This holds true whether your put your money in the bank or use it to buy stocks. One of the lowest-risk products available is a demand deposit account, such as a passbook savings account at your local bank. Because the Federal Deposit Insurance Corporation insures your account up to the maximum allowed by law -- $250,000 per signature on the account as of 2013 -- it's hard to find a much safer place to put your money. These accounts also pay among the lowest interest rates available.
Bank Rate Factors
Access to your money is one of the major factors in determining the rate of interest you'll receive on your deposits. The basic rule of thumb is, the longer you are willing to leave you money on deposit, the higher the interest rate the bank will pay. For example, you'll typically get a higher interest rate on a money market account that limits you to six withdrawals per month than you will on a passbook savings account, and you'll typically get a higher interest rate on a two-year certificate of deposit than you will get on a money market account. You might also get a bump-up in rates for depositing larger sums of money.
A dividend represents a portion of company earnings that the board of directors votes to pay to company shareholders. It is possible for a company's dividend rate to be significantly higher than prevailing interest rates. While some well-established, mature companies, sometimes referred to as blue chip companies, have paid regular quarterly dividends for years or even decades, there is no guarantee that any particular company will continue to pay dividends.
Beyond the possibility that a company might reduce or even eliminate its quarterly dividend, you take an even broader risk when you buy stocks when compared to putting your money in the bank. When you deposit money into a bank account, you are only loaning that money to the bank. The money is still yours, and since it is insured by the FDIC, your risk is limited to certain early withdrawal penalties on some types of accounts. Not so with stocks. When you buy shares of a stock, you are buying a piece of the company. If the company does well, you stand to earn a nice profit, because the price of the stock is likely to rise. But if the company does poorly, your stock might decrease in value, making your investment worth less than you paid for it.
- CNN Money: Tips For Investing In Stocks
- Forbes: Online Banks Offer Best Savings Account Rates For 2013
- Federal Deposit Insurance Corporation: Deposit Insurance Summary
- Ally Bank: Calculating CD Interest Rates
- Securities and Exchange Commission: When Are You Entitled to Stock and Cash Dividends
- ABC News: Dividends: Take the Money and Run
Mike Parker is a full-time writer, publisher and independent businessman. His background includes a career as an investments broker with such NYSE member firms as Edward Jones & Company, AG Edwards & Sons and Dean Witter. He helped launch DiscoverCard as one of the company's first merchant sales reps.