It’s possible to have too much money sitting in a savings account that earns little or no interest.
TJ Porter | Bankrate.com (TNS)
Saving money and having an emergency fund can help you handle unplanned expenses and provide peace of mind — especially in uncertain times. But stashing away too much cash might not be the best personal finance strategy, either. It’s possible to have too much money sitting in a savings account that earns little or no interest.
A liquid savings account is a safe place to keep some money that’s easily accessible. Insurance from the Federal Deposit Insurance Corp. (FDIC), which covers up to $250,000 per person, per account type at an FDIC-insured bank, means that your savings are protected by the federal government if your bank fails.
The risk of having too much money sitting in a savings account, assuming you don’t pass the $250,000 insurance threshold, is largely one of opportunity cost. Keeping too much of your spare cash in an account that generates little interest means you’re missing out on the opportunity to grow your money.
According to Bankrate data, the average savings account paid just 0.24 percent annual percentage yield (APY) as of April 26, 2023. However, you don’t have to settle for such a small yield. Right now, the best high-yield savings accounts pay 4 percent APY or higher.
Other deposit products carry similarly low risk, yet may pay a higher yield than savings accounts. You can find one-year CDs that pay an APY of over 5 percent, for instance. CDs aren’t the best place for money you might need access to before the term expires, however, since you’d likely be charged an early withdrawal penalty. They’re best for saving for time-specific goals.
Money market accounts currently pay similar yields to top savings accounts. Unlike CDs, these liquid accounts allow you to withdraw your funds at any time without penalty.
Instead of keeping extra money in a savings account, you could direct it into investments with greater growth and income potential, such as mutual funds, b onds, stocks, and exchange traded funds, or ETFs. These investments are riskier than a savings account, but may offer higher rewards.
Once you’ve decided how much money to set aside for emergencies, make sure your savings account balance reaches that threshold before you devote additional money to investments such as a taxable brokerage account or an IRA.
If you don’t have an emergency fund yet, it can help to start with small savings goals, such as $500 or $1,000, and work your way up from there.
“Your emergency fund should be at minimum three months of living expenses,” says financial educator Angel Radcliffe. “I would recommend six [months].” That means someone with monthly bills totaling $3,000 should have between $9,000 and $18,000 in savings before investing extra cash in higher-yielding investments.
Maintaining this savings cushion will enable you to cover unexpected expenses, such as a car repair or a medical bill. It also gives you a cash cushion to deal with a loss of income due to a job loss.
Financial coach and writer Katie Oelker says the amount you want to sock away in your emergency fund depends on your risk tolerance and personal situation.
“Once you have three months of expenses built up, ask yourself how much more you’d feel comfortable with,” Oelker says. “Is it six months? Nine months? Twelve months? A lot of this answer has to do with how comfortable you are with the risk of losing income, as well as how long you think you would need to stretch your [emergency] fund if needed.”
For example, if you’re part of a dual-income household, you might be able to get away with a smaller emergency fund if you can rely on your partner’s income if you lose your job. But if you’re the sole breadwinner for your household, you might want to have a larger emergency fund.
Once you’ve built your emergency fund, try to earn a safe but high rate of return on that money.
“While many save in a personal savings account for easy access for emergencies, there are other options to make the best of your savings for easy access to funds,” financial educator Radcliffe says. “Moving your savings to a high-interest savings account will help increase your yield.”
One of the first places to look for higher-yielding accounts should be online banks. They tend to offer some of the most competitive rates on savings accounts and might not have minimum balances or charge monthly fees.
Your financial goals can have a major impact on how much money you want to set aside in lower-yielding deposit accounts versus investments with greater growth potential like stocks.
For example, if you want to make a significant purchase — such as buying a home or a car — in the very near future, it makes sense to have a large amount of money in a savings account or CD. The last thing that you want is to save for a down payment by investing your money in the stock market, only to have your investments plummet in value as you start house hunting.
For longer-term goals, such as a retirement that’s decades away, investing can be the way to go. Financial coach Oelker recommends using tax-advantaged retirement accounts to invest once you’ve built your emergency fund.
“Once you’ve reached your goal, consider investing extra savings either by contributing more through an employer-sponsored plan, such as a 401k or 403b, or funding a Roth or traditional IRA,” Oelker says. “Every dollar you invest will compound. And the sooner you start padding your investment accounts, the harder your money will work for you.”
Having significantly more money in a savings account than you would need for emergencies can mean you’re losing out on higher potential returns elsewhere. Once you’ve built up savings for emergencies and short-term goals, additional funds could be earning better interest in FDIC-insured CDs or money market accounts, as well as stocks, bonds or mutual funds.
(Bankrate’s René Bennett contributed to an update of this article.)
©2023 Bankrate.com. Distributed by Tribune Content Agency, LLC.
