Ramit Sethi: Here’s the Costly Mistake Many Frugal People Make and How It Impedes Financial Growth

©Ramit Sethi

Commitment to Our Readers

GOBankingRates' editorial team is committed to bringing you unbiased reviews and information. We use data-driven methodologies to evaluate financial products and services - our reviews and ratings are not influenced by advertisers. You can read more about our editorial guidelines and our products and services review methodology.

20 Years
Helping You Live Richer

Reviewed
by Experts

Trusted by
Millions of Readers

For many people, frugality is one of the keys to long-term wealth generation. However, as financial personality Ramit Sethi noted in a recent Linkedin post, if you’re frugal to the point that you over-save, it can actually work against you.

Some may think that there is no such thing as “over-saving” — and obviously, having too much in savings is much better than having none at all — but if you’re really looking to make the best long-term financial decisions, having too much in your savings account won’t get you there. Here are the reasons that over-saving can be a costly mistake that’s all too common among frugal people.

You Aren’t Maximizing Your Growth

Savers have enjoyed some of the highest interest rates in decades in 2023, as the Fed has dramatically raised rates to help fight off inflation. Most high-yield savings accounts now pay in excess of 4%, with some approaching 5%, compared with the sub-1% yields that were common just a few years ago. 

However, even at those relatively high rates, savers aren’t moving toward their long-term goals as much as they should be. 

If you put $500 per month into a high-yield savings account paying 4%, for example, you’ll have about $347,000 after 30 years of saving and reinvesting. And that’s if rates can stay that high for 30 years. Remember, for years, the average yield even in high-yield savings accounts was well below 2%.

But if you instead put that money into an S&P 500 index fund, which has a long-term average return of roughly 10%, you’d have closer to $1.1 million instead. That’s more than three times as much money as if you had simply used a savings account. While many people could use $1.1 million to fund a long retirement, a $347,000 nest egg could run out faster than you might imagine.

You’re Earning a Negative Real Return

Any interest you earn from a savings account will be fully taxable at ordinary income tax rates. This means that if you’re in the 22% tax bracket, the 4% yield you earn really only amounts to 3.12% in your pocket — and that’s before deducting any state taxes and the effects of inflation.

With the CPI rate running at 3.2% as of the end of Oct. 2023, you’re actually earning a negative rate by keeping your money in a savings account. Only if your net income after taxes exceeds the rate of inflation are you actually generating additional buying power.

You Aren’t Making Tax-Deductible Contributions

When you put money in a retirement account, such as a traditional IRA or a 401(k), you’re getting a tax break on your contributions. If you put $5,000 into a 401(k), for example, that $5,000 is excluded from your taxable income. Similarly, if you make a $5,000 traditional IRA contribution, in many cases you can take a deduction for that when you file your taxes.

In both cases, your money also grows tax-deferred until you withdraw it. But money you put into your savings account generates no such tax benefits. You won’t get a tax deduction on money you simply save, and you’ll have to pay tax every year on any interest you earn.

You Aren’t Taking Advantage of Your Employer Match

The other huge mistake that overly frugal savers make is failing to maximize their employer match. Most companies that offer 401(k) plans agree to match a certain percentage of the amount that employees contribute.

For example, if you make a $5,000 401(k) contribution that amounts to 6% of your income, your employer might kick in an additional $2,500 or $5,000 to your account. That’s the closest thing there is to “free money” in the investment world, and it’s a much better option than simply keeping all your money parked in a savings account.

You Might Be Developing Bad Long-Term Habits

While it’s better to save too much than to outspend your income, you could still be developing bad long-term habits that can make things harder on you in retirement. 

For starters, you might have too much of an aversion to risk, which can cloud your judgment when making financial decisions. For example, you might never end up investing in the stock market because you’re more afraid of loss than gain, Or, you might avoid buying a house because you’re too afraid to take on any debt at all. Moves like this can harm your long-term financial security.

Another risk of being too frugal with your savings is that you might be setting yourself up to outlive your income. Somewhat ironically, this is often the biggest fear among many frugal savers. By stuffing as much money as you can into a savings account to ensure that you have enough for retirement, you may actually be increasing the odds that the opposite occurs.

Share This Article: