Savings accounts have been getting a bit of negative attention lately. Hilariously bad interest rates set against a backdrop of rising inflation and stellar growth across practically every investment class have a lot of people asking, are savings accounts still worth it?
Over the past decade, money invested in practically any diversified portfolio will have grown substantially. Meanwhile, the same amount of money in a typical savings account would actually be worth much less than it started due to inflation.
To many right now, it is a no-brainer: investing will make you money, the bank will cost you money. Why sit out all the potential growth?
Some have even gone so far to call savings accounts a risk to your money.
But there’s more to the picture than growth vs. stagnation. Let’s take a deeper look at exactly why people are so frustrated with savings accounts, as well as whether we still need them, and what (if any) is the point of a savings account in this climate.
Are Savings Accounts Really Necessary?
Let’s start with the case against savings accounts. Whether they still have a role to play or not, we can all agree that they’re not nearly as cool as they used to be, and that there are certain things they just can’t do.
Savings Accounts Won’t Make You Rich
At the time of this writing, the average savings account interest rate in the US is .06%. That’s 6% of 1%, for those keeping score at home. If you put 100 people in a room, .06% would amount to 6% of just one person. That’s like one left foot, total, out of the whole room.
It’s virtually uncontested at this point that a savings account is not going to make anyone rich.
Even the miracle of compounding interest makes almost no difference here. $100 earning that rate for 100 years would stack up to a heartbreaking total of just $106.18. The same deposit, earning 10% in a simple index fund portfolio over that period would grow to $1,378,061.23.
Savings Accounts Don’t Preserve Wealth
There was a time when a savings account could at least earn interest measured in whole percentage points (Pepperidge Farms remembers). Even as recently as a few years ago, it was still possible to find rates (mainly through online-only banks) in the 1-2% range.
With rates like that, it was not unreasonable to consider your savings account a counter to inflation. Cost of goods increased a couple percent this year, but so did the value of my savings. Even if I didn’t make money, at least it stayed flat.
Unfortunately, that’s not the case right now. At current rates, any money in a savings account will steadily lose value to inflation over time.
Is It Better to Have a Savings Account or to Invest?
If wealth-building was our only goal, the answer here would be clear. Putting our money into reasonable investments over the long term absolutely mops the floor with savings accounts in terms of growth. It’s like a baby trying to arm-wrestle Thanos. Or me trying to arm-wrestle Thanos. No contest.
But as you and I both know, wealth-building is not the only goal in life. It’s not even the only financial goal in life.
The question is not whether to save or to invest. It never was. What we have here is two different tools that do two different jobs. And the real question is, what is the role of each and how do we divide our resources between them?
The Purpose of a Savings Account
At the end of the day, the greatest thing our money can do is help us build a life of financial security, freedom, and independence. Of course, growing our wealth through long-term investing is a huge part of that. But it’s not the only part.
Think of your insurance. Insurance is not meant to make you rich. Anyone telling you different is no doubt selling insurance. But even though it’s not a good way to make money, it is a good way to protect your money. Insurance shields our money from various forms of disaster.
Savings accounts, like insurance, aren’t going to make you wealthy on their own. But they’re still an important piece of your financial life. Both exist to give you more restful nights, and freedom from financial anxiety.
Specifically, savings accounts help with this by offering stability and accessibility.
Sufficiently diversified investments will generally always grow over the long term. But day to day and month to month, there will be instability. This is why we invest for far-off goals like college and retirement, but not so much for, say, your trip to Aruba this spring.
10 years from now, you can be almost certain that well-invested money will have grown significantly. 5 months from now, there’s no guarantee the market won’t be having an off-day.
We know that savings accounts are boring and unsexy. But sometimes boring and unsexy is exactly what we need.
The amount of money in your bank account will never fluctuate on its own. It won’t skyrocket after a great earnings call, or plummet on bad PR or some mass panic. Even if your bank fails entirely, your money is still insured through the FDIC.
For money that you want ready access to on short notice, exactly as you left it, nothing beats a simple bank account for stability. And speaking of access…
I like to think of your checking and savings accounts, collectively, as the Grand Central Station of your money ecosystem. It’s where your income arrives, where your investments depart from, and all manner of deposits, transfers, and expenses pass through every month.
A place like that, with so much going on, is a place you want to be very easy to navigate. You want it to be accessible. And good bank accounts, compared to most investments and other account types, are extremely accessible.
Almost anything you need to do with your bank account, you can do online, instantly, 24/7. Check a balance, put money in, take money out, move money between places.
When you need to make a large payment in cash, or cover a big emergency expense, you don’t have time to wait for transaction approvals, trading floors, or communication between institutions. You need your money ready to go.
Savings accounts are as liquid as your money can get, and that is invaluable when you need it.
What Should Go in Your Savings Accounts
So we’ve seen what savings accounts can do, but what should we do with them? That is, what should actually go in a savings account? Going back to the earlier question, if investing and savings accounts are two separate tools, how do we know when to use which?
Is there a set dollar amount to aim for in one or the other, or maybe a percentage to divide up your money between the two?
Think of it like this: just like insurance, savings accounts serve a specific purpose. In both cases, we want to put in enough money to serve that purpose, but not much beyond that.
Below are three goals. They are three of the steps to achieving basic financial security, and all rely on checking and savings accounts. If you can check off all three of these, then that’s pretty much all you need. Anything you have beyond that should get to work buying you assets.
Your emergency fund is the money you have on hand, ready to deploy at a moment’s notice. Whatever goes wrong, whatever unexpected pies life throws in your face, this money is ready. It should be able to cover 3-6 months’ expenses, ideally sitting in its own private savings account.
To most folks, 3-6 months’ expenses is a large sum. Leaving that much money sitting in a savings account, earning essentially nothing, can be uncomfortable when you’re excited about investing. Many have tried to look for a more lucrative, but still safe place to put their emergency money, like CDs, bonds, or even index funds.
I urge you: do not do this. An emergency fund does not need to make you money. It is there so you can rest easy knowing that all but the most apocalyptic financial disasters can no longer harm you. Whatever comes, you want to be ready, and nothing beats savings accounts for that.
Current research shows that 54% of Americans live paycheck-to-paycheck, even including many high-earners. But getting out of the paycheck-to-paycheck cycle is much simpler (if not necessarily easier) than most people realize.
I’m by no means disparaging financial struggle. It’s there, and it’s real, and we’ve all felt it. But this specific part of it is actually pretty solvable. It only takes one thing: a buffer fund.
A buffer fund holds exactly one month’s income. At the beginning of each month, you pull your buffer fund and that becomes the money you have to spend that month. Everything you need for the whole month (assuming your budget is in check) is ready on day 1. No more waiting for the next check before you can pay a certain bill.
Then, the income you make this month becomes your new buffer fund for next month. Rinse and repeat!
You can create your own buffer fund by setting a little money aside until it adds up to one month’s income. This should be separate from your emergency money. If you can hit this goal, just one time, then you’re there! That is your first buffer fund. You’re now in a cycle of living off last month’s income, instead of anxiously waiting for next month’s income.
Cash for Upcoming Goals
This last one is pretty simple. If you’re saving up for some large expense in the near future, like putting money down on a house or taking a big trip, it’s best to keep that money in a savings account.
If your family trip next summer is going to cost $3,000, then you want to save up $3,000 (at LEAST, amirite?) and have that amount ready when you need it. You don’t need to turn it into $3,500, and you really don’t want to find out that it’s down to $2,500 when it’s time to pay for the flights.
Preparing for short-term goals is another place that boring is your friend. Ride a roller coaster when you get to your travel destination, not in saving up to pay for it.
Are You Taking Advantage of Savings Accounts?
Do you have your bank accounts set up for success?
If you’re on the way to financial security, they can help you get there!
If you’ve already passed that threshold, then you’re probably ready to start putting the rest of your savings to work with a simple investment portfolio and get on the road to financial freedom!
Thoughts, questions, or fiery opinions about savings accounts? Drop a comment below!