This post is here with reasons why you shouldn’t leave too much cash in a savings account. In today’s high-inflation environment, leaving a large sum of money sitting idle in a traditional savings account is essentially guaranteeing you’ll lose purchasing power over time.
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While it’s wise to have a modest emergency fund tucked away, parking excess cash in an account earning paltry interest rates could prove costlier than you think. Here are five compelling reasons why you should limit your savings account balance and put excess funds to work elsewhere.
Key Takeaways:
- Savings accounts pay miniscule interest rates, often under 1%
- With inflation over 6%, money in savings steadily loses value
- Your cash can grow faster in interest-bearing accounts or investments
- Having too much in savings robs your money of compounding potential
- Emergency funds should cover 3-6 months of expenses at most
5 Reasons Why You Shouldn’t Leave Too Much Cash in a Savings Account
There are several reasons why having too much cash sitting idle in a savings account might not be the best financial strategy. Here are five reasons why you shouldn’t leave too much cash in a savings account:
Today’s Leading High-Yield Savings Rates Can’t Keep Up With Inflation
Even the highest annual percentage yields (APYs) offered by many leading online-only banks and fintech companies top out around 4-5% as of mid-2024. While that’s the best rate environment in over a decade, it still falls well short of the current 6.5% inflation rate.
This means that if you have $10,000 sitting in one of those “high-yield” accounts, earning a generous 5% APY, you’re still effectively losing 1.5% of your savings’ purchasing power to inflation annually. The same $10,000 next year will only be able to buy you $9,850 worth of goods and services in today’s dollars.
Starting Balance | 5% APY | 6.5% Inflation | Year-End Value | Real Value After Inflation |
$10,000 | $500 | ($650) | $10,500 | $9,850 |
$25,000 | $1,250 | ($1,625) | $26,250 | $24,625 |
$50,000 | $2,500 | ($3,250) | $52,500 | $49,250 |
As the table illustrates, the higher your savings balance, the more critical it is to find an investment vehicle that can outpace inflation’s erosive effects.
You’re Missing Out On Compounding Growth Potential
One of the most powerful wealth-building tools is compound interest or investment returns. The earlier you put your money to work in an account or investment that generates compounding growth, the more you’ll benefit from exponential increases over decades.
However, by leaving too much cash sitting idle in a low-interest savings account, you’re depriving those funds of valuable compounding years that could snowball into a much larger nest egg over time.
For example, let’s compare leaving $25,000 in a savings account versus investing that sum:
Account Type | Starting Balance | 30 Year Balance |
5% Savings Account | $25,000 | $112,834 |
8% Average Annual Return | $25,000 | $227,012 |
After 30 years, the invested principal has doubled what it would have grown to in even a relatively high 5% savings account. That’s the immense power of compounding you’re sacrificing by leaving excess cash languishing in savings.
You’re Settling For Lower Real Returns
In addition to missing out on compounding growth, leaving too much money earning low savings account interest means you’re inherently settling for lower real returns after adjusting for inflation.
Real returns represent your nominal returns minus the current inflation rate. A savings account paying 5% against a 6.5% inflation rate yields a negative 1.5% real return for the reasons explained earlier.
By having a portion of your excess funds invested, either conservatively or more aggressively depending on your goals, you gain exposure to the market’s historically positive real returns over longer holding periods. This gives you a much better chance of staying ahead of inflation’s erosive effects.
Higher Taxes Upon Withdrawal
While savings account interest is relatively low to begin with, you’ll also pay higher income taxes on those meager yields versus earnings from tax-advantaged retirement accounts like IRAs or 401(k) plans.
Standard savings account interest gets taxed at your ordinary federal income tax rate as high as 37% for the highest earners. By contrast, qualified withdrawals from Roth accounts can be taken tax-free in retirement, while traditional IRA/401(k) withdrawals only get taxed at your potentially lower income tax rate in retirement.
So leaving your money sitting in savings means you’ll pay more taxes on those earnings compared to the tax advantages of diligently investing those funds into retirement products.
Lost Opportunity Cost From Not Investing
Let’s say you’ve maximized all your tax-advantaged retirement accounts and other investment vehicles, but still have additional cash sitting in savings that you won’t need for years. This excess sum is now losing value to inflation and being deprived of greater growth potential.
In this case, the “opportunity cost” of not investing that idle cash is quite high. Not only are you missing out on market returns that could significantly grow that surplus over the years or decades until your retirement, but you’re steadily eroding its value with each passing year of high inflation.
While investing always carries risks, including potential losses, a well-diversified portfolio has historically outperformed inflation over longer holding periods. Leaving funds to stagnate in savings instead carries its own inherent risk of losing purchasing power year after year.
Conclusion
While maintaining a modest emergency fund in cash is always wise, leaving too large of a balance earning pittance interest rates can severely hamper your long-term financial growth. With inflation still hovering near multi-decade highs, excess savings will steadily lose spending power with every passing year.
The solution is to leave just enough in savings to cover 3-6 months of essential expenses as a buffer for unexpected job losses or emergencies. Any surplus funds should be deployed into investments and interest-bearing products that give you a fighting chance to outpace inflation through compounding growth and market returns.
FAQs
How much should I keep in a basic savings account?
Most experts recommend keeping enough cash reserves to cover 3-6 months’ worth of essential living expenses in case of job loss or emergencies. Any amount beyond that buffer is better invested elsewhere to outpace inflation.
What are some good alternatives for cash that beats inflation?
Some options include maxing out tax-advantaged retirement accounts like 401(k)s and IRAs, opening taxable brokerage accounts invested in index funds, exploring rental real estate, peer-to-peer lending, I-Bonds, or other investments aligned with your goals and risk tolerance.
Aren’t investments too risky compared to a “safe” savings account?
Over longer holding periods of 10+ years, a diversified investment portfolio has historically provided positive real returns that outpace inflation – unlike cash constantly losing purchasing power. Savings accounts provide stability but little growth.
Should I take money out of savings accounts to invest elsewhere?
After maintaining your 3-6 month emergency fund, consider incrementally moving any excess savings into investments so that money doesn’t keep losing value to inflation year after year.
Do high-yield savings accounts solve the inflation problem?
While today’s leading high-yield savings accounts pay 4-5% APY, that’s still lower than the current 6.5%+ inflation rate as of 2024. So they provide better returns than basic savings, but your money will still be slowly losing purchasing power over time.
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