Just a few short years ago, online savings accounts were paying annual percentage yields of 2% or even more, making them a great place to stash cash. But with the onset of the coronavirus pandemic, the Federal Reserve quickly cut interest rates, dropping savings rates close to zero. Even the best online savings yields top out at about 0.50% these days. What this means is that for the past two years, savers have earned negative yields on their bank accounts, after factoring in inflation and taxes. And with inflation skyrocketing past 7% in recent months, savings accounts are falling woefully behind. So, are traditional savings accounts even worth it for you anymore? The answer is definitely yes — when they are used properly.
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When Are Savings Accounts Still Appropriate?
Savings accounts will never generate the big returns offered by asset classes like the stock market, but they serve valuable purposes that stocks and other investments can’t. Here are the top reasons why savings accounts are still appropriate.
They Carry FDIC Insurance
Probably the most important characteristic of a savings account is that it is FDIC insured. This means that your assets in the account, up to $250,000, are insured against loss by the federal government. Some bank accounts offer additional supplemental insurance that can bring the total amount up to $1 million or even more. This makes savings accounts the ideal vehicle for funds that you absolutely can’t lose, such as your emergency fund.
They Offer Liquidity
Savings accounts are generally accessible at any time. You can withdraw your funds from a branch any time it is open, and for accounts that offer debit cards, you can use an ATM machine to take out your funds as well. Even the stock market, which is also considered highly liquid, doesn’t offer this type of accessibility, as you must sell your stocks and then wait two business days after the sale to access your cash. For times when you need money right away, a savings account is one of the best available options.
They Can Help You Reach Your Short-Term Savings Goals
If you’re saving for a short-term goal, such as a wedding or a vacation, a savings account is usually your best option. Even if the interest currently paid on savings accounts is low, you will earn at least something while saving for your goal, and you won’t have to worry about losing value in the account even in a bad market environment.
When a Savings Account Just Doesn’t Cut It
The safety, security and liquidity of a savings account provide essential benefits that form the cornerstone of any financial plan. But there are times when your money is best served in a different type of account. These are just a few of those scenarios.
When Your Investment Objective Is Income
Many retirees, in addition to some other investors, live off the income from their portfolios. But if you’re looking to survive just on the interest that a savings account pays, you’re likely to come up woefully short of your goals. Even if you have $1 million saved, for example, the top online savings accounts will only pay you about $5,000 per year on that amount. Others might pay you as little as $100 annually. Although bond interest rates are low, high-quality instruments could still generate $30,000 or more per year on your $1 million nest egg, making them a better alternative. If generating enough income to live on is your financial goal, you’ll have to diversify the bulk of your assets away from a simple savings account.
When Your Investment Objective Is Growth
If you’re looking to maximize your investment returns, a savings account won’t be much help. Even if savings rates tick up to 2% or 3% — which may or may not even occur in the foreseeable future — growth investments like stocks can often return double-digit percentage rates, particularly over the long run. The average return of the S&P 500 index hovers around 10% annually, while individual stocks can return 100% or even more over the course of a year. This makes equities much more suitable to help achieve long-term investment goals like retirement savings than savings accounts.
The Bottom Line
Even with their currently low yields, savings accounts should always have a place in the portfolio of a well-rounded investor. The safety and stability of a savings account allow it to be a great home for emergency funds or short-term savings goals, something that all investors should have. But a savings account is not an investment account. It won’t likely generate enough income for you to live off, nor will it provide you with enough growth to reach your long-term investment goals. Properly used, however, it should still occupy an essential part of your overall portfolio.
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