fbpx Skip to main content

This post may contain affiliate links which may compensate us based on your interaction. Please read the disclosures for more information.

Overfunding a savings account with emergency cash isn’t always a safe idea. Learn what happens when you save too much. 

Image source: Getty Images

No matter what financial guru or planner you follow, most seem to agree on at least one principle: You should aim to have emergency savings stored in a safe, accessible place, like a savings account at a bank. Where they differ, however, is in how many months of savings you should have.

More often than not, financial experts will advise you to save between three to six months of living expenses. But it’s not uncommon to hear even larger numbers, like six to 12 months, or, for those nearing retirement, one to two years’ worth of emergency savings.

It’s important to have money set aside to cover surprise bills or help you stay afloat if you lose a source of income. But too much money in a savings account isn’t always a smart idea and could work against your ability to build wealth over long periods.

Inflation can work against big emergency funds

Emergency funds are best kept in FDIC-insured savings accounts, which have maximum security, little risk, and flexible withdrawals. These accounts are not the best choice for long-term growth, but they guarantee your money will be safe up to $250,000 per depositor per bank ($500,000 for a joint account).

The problem with savings accounts, however, is that their APYs often don’t outpace annual inflation. So while you might avoid investing risks by stashing large lump sums at a bank, you might also devalue your savings over a long period.

This year is unique in the sense that you can store money in a high-yield savings account with an APY that is above the annual inflation rate, which was 3% in June. Even so, the APYs on these accounts are not guaranteed and will fluctuate over time. You might earn 4.5% today — a great interest rate for a savings account — but if rates return to pre-2022 levels, outpacing inflation could become more difficult.

You could miss an opportunity to invest

Now, don’t get me wrong — if you’re near retirement, it might be wise to have more cash in a low-risk savings account. But for those who have long time horizons — who don’t plan to retire anytime soon — hoarding fat sums in a savings account can run the risk of growing your money too slowly and making it difficult for you to accomplish long-term financial goals, like saving for your retirement.

To grow your money at a higher rate of return, it might be a good idea to invest in the stock market, buy real estate, or start your own business. Not everyone is business-minded or wants to flip houses, but if you can stomach some risk, the S&P 500 could be a good place to park surplus savings. Over the last 30 years, the S&P 500 index has delivered a compound average growth rate of roughly 10.7% (before inflation). While you’re not guaranteed 10.7% every year, keeping your money invested in an ETF or mutual fund that follows the S&P 500 could return something close to that if you stay invested and don’t sell during market downturns.

Investing in individual stocks carry more risk and would require a more hands-on approach. You could, however, use a robo-advisor to help you create a portfolio that aligns with your risk tolerance and investing goals. Robots can’t guarantee you higher returns than the S&P 500 or even a rate higher than today’s top-paying CD. But keeping a long-term perspective and investing consistently over time has historically delivered investors better returns than the meager rates on savings accounts.

Strike a balance between saving and investing

Emergency funds are super important for your personal finance goals and can prevent you from depending too much on credit cards and personal loans. But if you’re overfunding a savings account because you’re worried you’ll lose money in other assets, you might be selling yourself short. A massive emergency fund might give you peace of mind today, but investing for the long term could give you greater financial security and a nest egg to retire on.

These savings accounts are FDIC insured and could earn you 11x your bank

Many people are missing out on guaranteed returns as their money languishes in a big bank savings account earning next to no interest. Our picks of the best online savings accounts can earn you 11x the national average savings account rate. Click here to uncover the best-in-class picks that landed a spot on our shortlist of the best savings accounts for 2023.

We’re firm believers in the Golden Rule, which is why editorial opinions are ours alone and have not been previously reviewed, approved, or endorsed by included advertisers.
The Ascent does not cover all offers on the market. Editorial content from The Ascent is separate from The Motley Fool editorial content and is created by a different analyst team.The Motley Fool has a disclosure policy.

 Read More 

Leave a Reply