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Should I use a savings account? This is probably a question that you have had when you got your first paycheck. For years, you probably thought that a savings account is the best place to store your money. It only makes sense, right? After all, the word “savings” is in the name. How can it not be a good place to store your money?
Well, there are a number of reasons why savings accounts are not the best. Overall, using savings accounts is an awful investment vehicle, simply because there are better options available.
This should be common knowledge, but this topic is. not taught nearly enough. Unfortunately, many are unfamiliar with the topics of investing and saving, and that should not be. However, that changes now, as in this article I explain why you should invest instead of using savings accounts.
Money Loses Value Over Time
First, we need to address a common question: Why should you even put your money anywhere? Why can’t you just hold onto it? Well, there is a simple answer to that question: inflation.
What is Inflation?
Inflation is the rate at which the prices of goods and services increase. In the United States, inflation is typically 2% annually. So, going forward, prices in the United States should increase 2% year over year.
If prices rise on a constant basis, that means your money actually loses value over time. In fact, with a 2% yearly inflation rate, your money loses about 2% of its value annually. The $1,000 you may have had two years ago is not the same $1,000 today.
Because of inflation, that $1,000 cannot buy you as much as it could have when you originally got it. Your buying power diminished due to rising prices. This phenomenon is referred to as the time value of money (TVM).
Many people look for returns on investment greater than the inflation to maintain the value of their money. This is known as beating inflation. They do not want their money to decrease in value after they worked so hard to obtain it. So, they look to put their money in places that will generate returns greater than the inflation rate. One of those places definitely is not a savings account.
Savings Accounts Don’t Beat Inflation
In order to beat inflation, you would need to realize a return greater than 2%. Do savings accounts have returns greater than 2%? Absolutely not. In fact, it is nowhere close. Not only do they not beat inflation, but the returns on savings accounts are also ridiculously small.
According to CNN.com, the average annual return for a savings account is 0.06%. For every year in a savings account, your deposit will grow less than one-tenth of a percent. To better picture, if you had $10,000 deposited in a savings account, you would gain $6 in interest for the year. To see such a small return off a large principal investment is insanity.
Storing your money in a savings account typically does not protect it from inflation. Rather, it actually allows your money to lose value over time, as the returns are just so low.
Let’s look at the net return. The net return would be the return of the savings account less the inflation rate. If the return on a savings account is 0.06% and inflation is 2%, then the net return would be -1.94%. So, if you park your money in a savings account, then your hard-earned cash is not protected from inflation. It still would lose significant value year-over-year. Thus, it is probably wise to look at other ways to invest your money.
Let’s Look at Stocks
You may be asking: well, if I don’t use a savings account, where can I put my money? Luckily, the answer for that is simple: the stock market.
Investing in the stock market ensures that your money does not lose value over time. In fact, it is almost a guarantee that your money will grow in the long-term if held in stocks.
According to Investopedia, the average annual return from the S&P 500 is around 8%. In terms of net return, it would be roughly 6%, since it would be the stock market return less inflation. Through the stock market, you would be beat inflation by a significant margin. Doing so would also allow your money to grow tremendously in value, as a result.
This return is over 133 times greater than the average interest from a savings account. If you had invested that $10,000 instead of putting it in a savings account, you would have realized $800 in gains. Without including dividend payments, this would be a difference of over $730 annually.
Further, with investing, there is no ceiling on possible returns, while savings accounts fix the return at a predetermined rate. With the stock market, an investor chooses where their money goes to optimize their returns, which will be much higher than the average 0.06% return if done correctly.
The stock market is a means to generate wealth. It is probably the best approach for younger individuals to pursue financial freedom in the long-term. Savings accounts, on the other hand, do not do anything of significance.
I could not even say that they preserve wealth, because they really don’t even do that. Your investment loses value over time in a savings account. So, if you are looking to create wealth or preserve it, then there are other investment vehicles to consider.
However, there are some savings accounts that do offer higher yields. These accounts are probably the most enticing options, as they preserve wealth the best.
High-Interest Savings Accounts
A number of banks have been offering higher interest rates, some near 2%. This savings accounts allow you to fight inflation much better than traditional ones. However, they largely still do not beat inflation.
With the current state of the economy, interest rates are at historic lows. As a result, many banks were forced to lower the yields on their savings accounts. Consequently, many accounts with yields over 2% are now below 1%. This means that these accounts still result in a loss of value for your money.
Even with there being high yielding options available, many are not taking advantage. Roughly 7 out of 10 Americans utilize a savings account that pays less than 2% interest. That is the majority of Americans, and it should not be. If you are going to have a savings account, you should definitely look to have the highest yield possible.
Should You Avoid Savings Accounts Entirely?
Should you avoid savings accounts entirely? Absolutely not. I am very against savings accounts being used as an investment. However, savings accounts do have their own purpose.
Savings accounts can be great supplements for investing, especially for an emergency fund, or if you want to store your money before a big purchase.
Savings accounts are not volatile at all, unlike stocks. Although the value of your investment will lose money, you will not actually lose money with a savings account. This means that savings accounts can provide security to the individual. Because there are not fluctuations, they will know the exact amount in their savings account at any given time.
What are Emergency Funds?
An emergency fund is exactly what it sounds like. It is a savings account meant for only financial emergencies. They are most often used to cover expenses in the case of losing your job. If you lose your job but you have an emergency fund, you will be able to live your life normally until you land on your feet with a new job.
An emergency fund can also be utilized for other unplanned events, such as a car accident or a hospital bill. Without an emergency fund, one of these events could be devastating to your finances. You may have to sacrifice to make these payments. These sacrifices could include having to cut back on personal spending or selling investments just to cover the payme1nts. This should not be.
If you have an emergency fund, you do not need to worry about this every happening. You will always have enough to pay for emergency expenses, which secures your current lifestyle. No sacrifices would be required, and you can rest easily knowing that.
How Much Should Be in an Emergency Fund?
Typically, the recommendation for how much you should have in an emergency fund is three-to-six months worth of expenses. This is so you would be able to cover any expenses if you lost your job and are looking for a new one.
Due to the pandemic, some have advised that more should be saved in an emergency fund. I have seen recommendations as high as one year’s worth of expenses saved. This is a rather high figure to reach, but it could very well be worth it.
The pandemic led to the layoffs of thousands of workers, making life very hard for these individuals. If they had a year’s worth of expenses saved prior to this, they would be able to live life as normal until they find a new job.
Again, having this much saved is a rather hard goal to achieve, which is why I think three-to-six months saved is more reasonable. Regardless, having too much in this account is definitely not a bad thing.
It is worth noting that you should add additional funds to this account after making a withdrawal. If you had to use this fund to pay for emergency, you should look to replace the funds you withdrew. This way, you will always have the right amount in the account.
Final Takeaway of Savings Accounts
Savings accounts definitely have their place. They are great for creating emergency funds or saving up for large purchases, like a home. This is because they are not volatile in nature, which allows individuals to plan to use their money more effectively.
However, that is the extent of their benefits. Other than that, savings accounts are rather awful. They offer very low yields compared to other investment options and do not even beat inflation. So, not only are you not making money on your investment, your money is actually losing its value over time. That is definitely not what you want.
Savings accounts are for emergency funds and saving for purchases. They are not used to generate wealth and make money. That can be done on the stock market, which is one of the best ways to create wealth in the long-term. Do not let a savings account be one of the reasons why you do not start investing. Invest now, and do not rely on a savings account for gains.
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