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Having money in savings is a good thing, but having too much isn’t, due to opportunity cost. Here’s how much you could lose if you misallocate your assets.
Putting money into a high-yield savings account is indisputably a smart financial move. You need some money in savings to cover emergency expenses so you don’t end up in credit card debt. If you have short-term financial goals you’re saving for, like putting a down payment on a house so you can qualify for a mortgage loan, this money should be in savings as well.
But it is not a smart financial decision to keep too much money in savings. If you do that, there’s a big opportunity cost, and you could end up making your net worth a lot smaller.
Just how much could you lose if you keep too much in your savings account? Here’s what you need to know.
The opportunity cost of a too-big savings account balance
The big problem with having too much in savings is the opportunity cost. Every extra dollar that you put into a savings account when you don’t really need it there is money that you cannot invest. And if you invest, you can typically earn a much higher rate of return than you could by putting your cash into a savings account offering even the most competitive rate.
Let’s say, for example, that you were consistently able to earn a 3% average annual return in your savings account — which is very optimistic, given that the national average savings account rate is just 0.43% as of Aug. 21, 2023 (high-yield accounts tend to pay much more than the national average). In contrast, you might reliably expect to earn a 10% average annual return if you put your money into a brokerage account and bought shares of an S&P 500 index fund.
So, how much could you lose by accepting a rate of return that’s so much lower if you stick too much in savings? It depends on the amount you have in your account and your timeline.
The table below gives you an idea of the opportunity cost you would experience if you kept too much in savings over the course of five years versus investing it via a brokerage account instead.
As you can see, you will lose out on thousands of dollars even if you don’t have a ton of extra money in savings and even if it’s only left there for a relatively short period of time.
How much should you put in savings?
You can’t afford the opportunity cost of overloading your savings account. To make sure you aren’t losing your chance at earning thousands of dollars extra by investing money that should be in the market, keep this in mind:
Money should be kept in savings if you may need it at any moment. This applies to an emergency fund or money you’re saving for expenses like car repairs. You don’t want to have to sell investments to pay for surprise bills or be forced to go into credit card debt to cover them.Money should be kept in savings if you’ll need it in the next two to five years. When investing, you want to make sure you have time to wait out any potential market downturn that occurs. If you have a short time period before you’ll need the funds, the risk of investing is too great.
Any money you won’t need for a while should be put into the market instead of a high-yield savings account. As the table above shows, the opportunity cost of not doing so is simply too great.
Fortunately, investing can be pretty easy. Open a brokerage account, move that extra money into it, and start researching investments that make sense for you. If you’re not sure where to start, some inexpensive exchange-traded funds (ETFs) that track the performance of the S&P 500 can be a simple option, or you can do some research and develop a comprehensive investing plan of your own.
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