Overfunding Your Savings Account Could Hurt You. Here's Why

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KEY POINTS

  • It's important to keep money in savings for emergencies and near-term goals.
  • Stashing too much cash in savings could cause you to miss out on potential gains you could have made if you'd invested it.
  • Strike a balance between the amount you put into savings and into the stock market.

When it comes to funding a savings account, there is such a thing as going overboard.

There's a reason it's important to keep money in a savings account: You need cash on hand at all times in case an unplanned expense arises that your paycheck can't cover. And on top of your emergency fund, you may need cash in the bank that you have earmarked for a shorter-term savings goal, like buying a home or taking a big vacation.

But there may come a point where you actually end up with too much cash in your savings account. And that's a situation you'll want to avoid.

The danger of keeping too much money in cash

The upside of stashing money in your savings account is having your principal protected. If you put $50,000 into the bank, that $50,000 is guaranteed to be there for you no matter when you decide to take a withdrawal.

By contrast, when you invest money in a brokerage account, the value of your investments can fluctuate based on market conditions. And so if you invest $50,000 and need cash three years later, at that point, your investments may only be worth $45,000. Cashing out could therefore mean taking a permanent loss.

That's why a savings account is the most appropriate place for your emergency fund and for money you expect to need within a few years, such as the cash you're tucking away for a down payment on a home or an upcoming renovation project. But once your emergency fund is complete and you've saved enough for your near-term goals, it does pay to start putting money into a brokerage account.

See, savings accounts are nice and secure, but they only pay a limited amount of interest. Meanwhile, if you invest money in a brokerage account, you might earn a substantially higher return than what your savings account will pay you.

Of course, in exchange for that higher return, you're taking on some risk. But if you're investing over many years, that's a risk you can afford to take on.

The stock market has a tendency to recover from downturns, but it can take time for that to happen. But if you're investing over, say, 20 years, that's plenty of time for your portfolio to turn around if it takes a hit.

Now, imagine you decide to keep your retirement savings in the bank. If you do so, over time, the rate of inflation might easily outpace the interest rate you're earning on your money. If that happens, by the time you leave the workforce, you'll be short on cash. On the other hand, if you invest that money, there's a good chance you'll match or outpace the rate of inflation so that you're left with more buying power once you retire.

Don't play it too safe

A savings account is definitely the safest option when it comes to finding a home for your money. But if you limit yourself to the lower interest rates that savings accounts pay, you might deny yourself the growth on your money you need to meet longer-term goals, like a secure retirement.

So go ahead and beef up your savings account if you feel it could use some work. But once you have enough money for emergencies and short-term goals, do yourself a favor and start investing. Your future self will thank you for it.

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Rates as of Apr 17, 2024 Ratings Methodology
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