Savings accounts have had a slow and steady fall from grace since their heyday some decades ago. Hilariously bad interest rates against a backdrop of rising inflation and rapid growth across practically every investment class have many 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 be worth considerably less than it started due to inflation.
This climate has led many to turn towards other vehicles for financial growth, calling bank accounts useless or even harmful to one’s personal finances.
Today, let’s take a deeper look at why people are so frustrated with savings accounts, whether we still need them, and what (if any) is the point of a savings account in this climate.
Are Savings Accounts 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 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. Imagine you put 100 people in a room. .06% of that room would amount to 6% of just one person. That’s like one left foot out of a whole room full of people.
It’s virtually uncontested at this point that a checking account or savings account will not make anyone rich. Even money market accounts and so-called high-yield savings accounts offer dishearteningly low annual percentage yields.
Even the miracle of compound interest makes almost no difference here. $100 earning that rate for 100 years would stack up to a heartbreaking total of just $106.18. An identical deposit, gaining 10% in a simple index fund portfolio over that timeframe, would grow to $1,378,061.23.
Savings Accounts Don’t Preserve Wealth
There was a time when a bank account holder could earn interest measured in whole percentage points. As recently as a few years ago, it was still possible to find savings account rates (mainly through online banks) in the 1-2% range.
With rates like that, it was not unreasonable to consider your savings account a counter to inflation. The cost of goods typically increased a couple of percent per year, but so did the value of money in a savings account. So even if it didn’t make money, at least it stayed flat.
Unfortunately, that’s not the case right now. At the current low rates, any money deposited in a regular savings account will steadily lose value to inflation over time.
Is It Better to Have a Savings Account or to Invest?
If wealth-building were our only goal, the answer here would be clear. Putting our money into reasonable investments over the long term 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.
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 invest. It never was. What we have here are two different tools that do two different jobs. And what we need to know now is the role and value of each one.
The Purpose of a Savings Account
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 massive part of that. But it’s not the only part.
Think of your insurance. The point of insurance is not to make you rich. Anyone telling you different is no doubt selling insurance. But even though it’s not an effective way to make money, it is an effective way to protect your money. Insurance shields our money from various forms of disaster.
Savings accounts, like insurance, won’t make you wealthy alone. But they’re still an essential 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 rather than imminent ones like an upcoming trip to Aruba.
Ten years from now, you can be almost sure that well-invested money will have grown significantly. But on the other hand, five months from now, there’s no guarantee the market won’t have an off-day.
We know that savings accounts are boring and unsexy. But sometimes boring and unsexy is the thing we need.
The amount of money in your bank account will never fluctuate without outside involvement. It won’t skyrocket after a great earnings call, plummet on bad PR, or crash due to some mass panic. Your money is still insured through the FDIC even if your bank fails.
Nothing beats a simple bank account for stability for the money you want ready access to on short notice, exactly as you left it.
One way to think of your checking and savings accounts is the Grand Central Station of your money ecosystem. It’s where your income arrives, your investments depart from, and countless deposits, transfers, and expenses pass through every month. When you need to make a withdrawal or hit an ATM, these accounts are your first stop.
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 the best savings accounts, compared to most investments and other account types, are highly accessible.
You can now manage most of your financial housekeeping through online and mobile banking, instantly, 24/7. Check a balance, put money in, take money out, or transfer money between places.
When you need to make a large payment in cash or cover a significant emergency expense, you don’t have time to wait for transaction approvals, trading floors, or communication between institutions. You need your money ready to withdraw.
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 go in a personal savings account? Returning 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 is there maybe a percentage to divide your money between the two?
Consider it like this: savings accounts serve a specific purpose, just like insurance. In both cases, we want to put in enough money to serve that purpose, but not much beyond that.
Below are three goals. They all rely on checking and savings accounts. If you can check off all three of these, you’ll be in good shape with your bank accounts. Anything you have beyond that would usually be better off buying assets.
Your emergency fund is the money you have on hand, ready to deploy at a moment’s notice. Whatever happens, whatever unexpected pies life throws in your face, this money is ready. It should be enough to cover 3-6 months’ expenses, ideally sitting in its own private savings account.
To most folks, 3-6 months’ expenses make up a large sum. Leaving that much money sitting in a savings account, earning essentially nothing, can be uncomfortable when you’re excited about investing. As a result, many have tried looking for more lucrative savings products to hold their emergency money, like certificates of deposit (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.
Research shows that 54% of Americans live paycheck-to-paycheck, 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 pretty solvable. It only takes one thing: a buffer fund.
A buffer fund holds precisely one month’s income. At the beginning of each month, you pull your buffer fund, which becomes the money you have available for that month. Everything you need for the month (assuming your budget is in check) is ready on day 1. That means no more waiting for the next paycheck before you can pay a particular bill.
Then, the income you make this month becomes your new buffer fund for next month. Rinse and repeat!
You can create a buffer fund by setting a little money aside until it adds up to one month’s income. This allotment 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.
Cash for Upcoming Goals
This last one is pretty simple. If you’re saving up for some considerable 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 will cost $3,000, you want to save up $3,000 and have that amount ready when you need it. You don’t need to turn it into $3,500, and you especially 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 while saving 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, 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!