Savings Accounts | Here’s How Saving Too Much Can Backfire
Not everyone has an emergency fund tucked away in savings. In fact, a recent GoBankingRates study identified that 69% of Americans have less than $1,000 available in a savings account, and 34% of this group has no money saved at all. The Federal Reserve Bank recommends that Americans set aside $2,000 to cover an emergency.
Conversely, some Americans have too much money in savings. Frugal people should note that overfunding their savings account could limit their ability to accumulate wealth. Here is what you need to know:
With too much in savings, you cannot significantly grow your money.
Today, most savings accounts pay 1% interest or less. This means the money stashed away in your savings account cannot grow in any substantial way. Granted, the purpose of an emergency fund is to have a safety net on hand, but the truth is that some of those funds would be better off invested. You wouldn’t want to fall short when you truly need the money in retirement.
Not only that, but inflation will make your savings worth less over time.
Risk-averse savers, who steer clear of investing in order to keep their earnings in savings, should note that in the United States, the average rate of inflation is approximately 3%. This means that to avoid losing money, you must plan for a return of at least 3% on your savings at the end of each year.
And while there have been times when interest rates increased to the point of providing more than a 3% return on a savings account, these periods have traditionally been linked to even higher inflation rates than the norm.
In simple terms, savings accounts will very rarely allow consumers to beat inflation. Sound investments will almost always yield much greater returns.
So what is the ideal amount of money to keep in savings?
While consumers shouldn’t invest their savings without an adequate emergency fund, it can be difficult to determine the point at which you have enough money saved. Typically, people need three to six months’ worth of living expenses in the bank, although it wouldn’t hurt to save more. For example, if you are self-employed and your income is unpredictable, or if you are the sole earner in your family, then you should aim to save nine months’ worth of living expenses.
In most cases, however, there’s no need to keep more than a year’s worth of cash in your savings account. By overfunding your account, you will limit your ability to compound your money — or earn additional interest based on the increasing value of your investments.
Explore your options.
There are a number of ways consumers can invest their money. Investment portfolios, for instance, can generate significant returns. While it takes about 10 years to overcome stock market volatility, you will almost definitely come out ahead in the long term. As discussed, most savings accounts generate a 1% return. Stock-focused portfolios, on the other hand, can earn an 8% return over 30 years.
In addition, consumers can explore traditional brokerage accounts, or IRA and 401(k) accounts on which you only pay taxes when you make a withdrawal in retirement. There are a number of ways to generate significant returns, and still have an emergency fund available to cover any unexpected expenses.
Ultimately, while it’s certainly beneficial to save money, versatility is key. A fixation on growing your savings account can limit your ability to make even more money by investing your income.