High school students are rarely offered financial literacy courses. The most we are usually taught is to just “save money” because 4 out of 10 Americans can’t cover a $400 emergency expense (Board of Governors of the Federal Reserve, 2018). Teens should definitely build an emergency savings first but then consider investing, which historically has achieved higher returns when compared to saving.
Creating an emergency fund is a smart decision to make, but it should only be your beginning. “Having an emergency fund gives you a safety net to protect you in times of uncertainty without having financial stress”(Olunwa, 2020). “On average, an emergency fund should cover 3 to 6 months of basic essentials.” Once you have enough money saved to cover 3 to 6 months of basic essentials, many young adults often start to consider investing.
One of the reasons for this is inflation. Inflation must be taken into account when deciding how to manage your money. In simplified terms, inflation is the decrease in the purchasing power of a nation’s currency. The average annual inflation rate of the U.S. dollar is 2.1% (“Historical Inflation Rates: 1914- 2019”). Due to inflation, the cost of goods and services will continue to increase over time. Thus, the amount of money that you have saved won’t be as valuable.
Long term investing in a diversified portfolio has historically achieved higher returns compared to a savings account. For example, SPY, an exchange-traded fund that measures the stock performance of 500 large companies listed on stock exchanges in the United States, has a historical average annual growth rate of 8% after accounting for inflation. In comparison, the average savings account has an annual decay rate of 2% after accounting for inflation. Not only do you lose purchasing power long-term, but you also miss out on the gains of investing in the stock market.
Whether you are investing or saving, either financial choice will take you further than just spending all your money. Florin Nicola, a junior at Northside College Prep, agrees with this sentiment. “It is often tempting for me to spend the money I earn on designer clothes. [Spending] provides me with instant gratification. However, I know that it is in my best interest to create an emergency fund at an early age as it will help me in the future in case of an emergency (Nicola, 2020).”