Have extra money in your savings account and not sure what to do with it? Find out 5 reasons why you should rethink this decision and consider other options for investing it.
As a saver, you are constantly trying to make the best decision when it comes to your money. You want to make sure it is secure and well taken care of.
A savings account is a great way to ensure that your money is safe, but before you decide to keep extra cash in there, there are some factors you should consider.
From low interest rates to risk of inflation, there are several reasons why keeping too much money in a savings account might not be the best course of action.
In this article, we will explore 5 reasons why you should rethink keeping extra money in your savings account.
We’ll look at how low interest rates can affect your returns and the risk of inflation on your stored cash, as well as the opportunity cost of having too much money saved away from potential investments and other sources of income.
We’ll also examine how quickly accessible a savings account can be, as well as the lack of tax benefits associated with them.
- Low interest rates on savings accounts may result in low returns compared to other investments such as stocks and bonds.
- Inflation can erode the purchasing power of money stored in a savings account.
- Opportunity cost of not investing extra money in higher performing assets.
- Savings accounts may not offer tax benefits.
- Accessibility of savings accounts may not always be quick enough for emergency situations.
Table of Contents
1. Low Interest Rates
As an investor, it’s important to understand the risks and rewards of different types of financial vehicles. Keeping too much money in a savings account can be detrimental due to low interest rates.
The annual percentage yield (APY) on savings accounts is often far lower than what you’d get from other investments, such as stocks and bonds.
For example, a typical savings account may provide an APY of 0.10%, while investing in a S&P 500 index fund may yield 6-7%.
That means the same amount of money deposited in a savings account would earn only 1/60th or 1/70th of what could potentially be earned in the stock market over the same period.
2. Risk of Inflation
I keep extra money in my savings account because I’m aware of the risks of not having access to it when I need it.
But what I may not be considering is that having too much money stored away in a savings account for an extended period of time can actually put me at risk of losing purchasing power due to inflation.
Inflation is the sustained increase in prices over time and affects the amount of goods and services that can be purchased with a given amount of money.
The value of what your money can buy decreases as prices go up, which means that if you have some cash stored away, but are not taking advantage of higher-yielding investments, the buying power of your dollars will slowly erode with inflation.
For example, let’s say that you have $5,000 in your savings account earning 0.2% interest annually. If inflation is 3%, then after one year, your purchasing power has decreased by around 2%.
That’s equivalent to losing $100 in real purchasing power after a single year!
To maximize my savings and protect against inflation, I need to think beyond just keeping my extra money in my savings account and consider alternative options such as investing or using high-yield online banking accounts.
While there may be some risks associated with these alternatives, they can help me maintain or even grow my purchasing power over time—something which isn’t possible if I just keep all of my extra cash tucked away in a traditional savings account.
3. Opportunity Cost
When it comes to saving money, you need to consider the opportunity cost of keeping your extra funds in a savings account. By leaving your money in a savings account, you are sacrificing the potential benefits that other investments can offer.
For example, if you had invested the same amount of money into stocks or mutual funds, you could have earned far more than what a savings account would pay out in interest.
On average, stock returns have historically been higher than those from cash. Additionally, you could benefit from capital gains taxes if you sold stocks at a profit.
Moreover, when leaving extra money in a savings account, it is difficult to keep track of inflation rates and how they affect the purchasing power of your funds.
You may find that by not investing or reinvesting your funds in better performing assets, their spending power could be eroded over time as inflation takes its toll.
4. Easily Accessible
As someone who doesn’t like to keep too much money in savings, I understand the attraction of ensuring that my money is easily accessible.
Having it stored in a savings account makes it easy to withdraw whenever I want without having to go through lots of paperwork or wait for long processing times.
However, this convenience of access can come at a cost because when money is readily available and easy to access, there is more temptation to spend it on unnecessary things.
Having money in a savings account with low interest rates means that I’m not getting the most out of my money by letting it sit idle.
Instead, investing the money elsewhere would help me earn higher returns and make my savings grow at a faster rate than what’s offered by the bank.
This way, even if I need access to my funds quickly, I have them invested in something that will continue to earn me returns with minimal effort on my part.
5. No Tax Benefits
As an individual investor, it is important to understand the implications of keeping extra money in a savings account.
One downside is that there are no tax benefits to using a savings account. Investing your extra cash in a 401(k), IRA, or other tax-advantaged plan can help you maximize your return on investment and realize greater wealth over time.
In comparison, with a savings account, all income from interest earned on funds deposited will be taxed at the regular income tax rate.
This means that you must pay taxes on any earnings made from the interest accrued on your balance in the account.
Additionally, you are not able to claim any deductions for contributions made to your savings account, which puts it at a disadvantage compared to other forms of investing like 401(k)s or IRAs.
The lack of special tax benefits for saving money also has potential long-term effects on individuals who rely solely on their savings accounts for retirement planning.
Without taking advantage of tax-favored investments like Roth IRAs or employer-sponsored plans such as 401(k)s, individuals can miss out on future tax breaks and risk not having enough saved when they reach retirement age.
For those looking to make their money work harder than just leaving it in a low-interest bearing savings account, it is important to consider investing options that offer more favorable terms and better returns than what traditional banks offer.
There are many options available for investors today, so taking the time to research each one can ensure that you get the best return on your investment while minimizing potential taxes.
As a conclusion, it’s important to consider the pros and cons of keeping extra money in your savings account.
While low interest rates and no tax benefits can be a deterrent, having easily accessible funds in case of emergency or costly opportunities is an advantage.
If you are considering other options for investing your money, it’s important to look at potential risks such as inflation and the opportunity cost of not taking advantage of more profitable investments.
Ultimately, it’s up to you to decide what is best for your financial situation.
- Shivani is a personal finance expert who covers topics from credit cards to travel rewards. She's featured in Prestige Magazine and passionate about helping readers make responsible financial decisions. Based in New Delhi, she travels as a digital nomad, sharing her knowledge worldwide.