What Keeping Your Money in a Savings Account Costs You in Lost Investment Gains
No one would argue against the safety of stockpiling money into a savings account. However, playing it safe robs you of better interest rates and potentially tremendous wealth building opportunities elsewhere.
Finding the right balance is crucial. The returns you miss by not investing your savings could be life-changing. However, savings accounts provide liquidity and protection, and they are dependable caches to grow an emergency fund or save for a short-term expense.
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“Factors like age, career, job security, medical issues, risk tolerance, current wealth and assets are part of any decision to invest and save,” said Dan Strachman, Managing Partner at A&C Advisors LLC. “For some, putting money into a high-yield savings account may be the best option for them.”
However, regardless of your income, you need to think more sensibly about getting the most out of your money. As personal finance author Robert G. Allen purportedly said, “How many millionaires do you know who have become wealthy by investing in savings accounts? I rest my case.”
Here’s what some other experts have to say about the opportunity costs of keeping your money in savings.
Interest: Your Savings Aren’t Earning Enough
Compared to keeping your money in a basic (or even a high-interest) savings account, almost every other investment option will make more money. This includes GICs, money market funds, bonds and index funds and ETFs.
“Over the past decade, many savings accounts in the U.S. have generated less than 1% annually on average, with some large-bank accounts paying close to 0% for extended periods,” said Nadeem Kassam, Chief Investment Strategist at Marnoa Private Wealth Counsel.
According to Jeff Bell, Managing Editor and Operator with The Broke Backpacker, there are other concerns about strict savings when it comes to taxes.
“When you put your money in a savings account, the interest it earns gets taxed as ordinary income every single year, meaning the IRS takes a cut of every dollar your account earns whether you touch it or not,” Bell said.
“Investment gains in an index fund work differently," he added. "You only pay tax when you sell, and at the lower capital gains rate. So the savings account is not only earning less compared to an investment account, but is also being taxed harder the whole time it's there. Basically, you are paying more tax on money that is already earning less. This is a double loss and it grows bigger every year.”
Compounding: Missing Out on Years of Growth
The cost of waiting to invest or doing nothing is immense.
“The greatest loss isn't simply a lower interest rate," said veteran investor, educator and author Arie Brish, "It's missing decades of compound growth. Even investing $100 per month can grow to roughly $226,000 over 30 years at a 10% annual return, compared with about $58,000 in a 3% savings account.”
Paul Ferrara, Senior Wealth Counsellor and Client Relationship Manager at Avenue Investment Management, agreed on the importance of compounding interest.
“I have witnessed clients delay investing until they feel they have the resources to do so and then discover that they missed out on accumulating sufficient funds,” he said. “The only ingredient that compounding needs is time: a dollar that doesn't get invested loses the working years that it can never come back for.”
Inflation: The Loss of Purchasing Power
Inflation represents another cost of hoarding too much cash. As said, inflation may increase more quickly than the annual yield on your account, even if your savings generate interest.
“Money in a savings account seems secure, but inflation is working against you each day,” Ferrara said. “You may be increasing your wealth by increasing your inflation, if your inflation rate is higher than your savings rate."
“Even many high-interest savings accounts only modestly outpace inflation,” Kassam said. “As a result, cash held in savings for long periods can lose purchasing power over time. In practical terms, the same amount of money will likely buy significantly less in 20 years than it does today.”
Giving your money the opportunity to grow is one of the smartest investment decisions you can make, especially if you begin early. However, the key is finding the right balance. Money you'll need within the next year or two — such as for a home purchase, taxes or emergency expenses — belongs in safe, liquid accounts.
This article was provided by MoneyLion.com for informational purposes only and should not be construed as financial, legal or tax advice.
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