How Much Money Is Too Much To Keep in Your Savings Account?
Can you have too much money in the bank? On the one hand, there’s an obvious joke answer to this commonly asked question — there’s no such thing as “too much money.” The reality, however, is regardless of how much money you have, in order to maximize your net worth you shouldn’t keep too much money in your savings account.
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While savings accounts serve valuable functions, they aren’t “investments” in the strictest sense of the word. As you’ll see below, savings accounts typically act as a drag on your portfolio rather than an enhancement. That’s why there is definitely such a thing as having “too much money” in your savings account.
Negative Real Returns
Although savings accounts are FDIC insured and among the safest places to keep money for things like emergencies, in terms of an investment strategy, having too much money in a savings account is catastrophic. For starters, savings accounts typically pay among the lowest yields you can find in the investment world. While this may be a fair tradeoff for their security, they may actually reduce your net worth. After you factor in inflation and taxes, for example, the “real return” you earn on money in a savings account is typically negative.
Using a real-world example can help make this clear. In 2022, online savings account yields jumped up close to 4% thanks to the Fed aggressively raising interest rates to combat inflation. Across the country, savers jumped up and down with glee, as rates as low as 0.01% had been the norm in the not-too-recent past. But even with that major move in rates, savings accounts were still losers when it came to real returns in 2022.
Even if you could snag a rate of 4%, you’d have to make that money stretch in an environment where inflation topped 9% in June and finished the year at 7.7%. Net-net, even with a 4% savings account yield, you were looking at a negative real return somewhere between -3.7% and -5% throughout the year — and this was before factoring in taxes, which could have taken a bite of 20% or more out of your 4% yield.
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FDIC Insurance Limits
If you’re in the fortunate enough position that you have hundreds of thousands of dollars available for savings and investments, there’s another reason why you’d want to avoid putting too much money into your savings account. While savings accounts carry FDIC insurance, the amount is limited to $250,000 per account holder for every account. This means if you open a savings account and dump in $1 million, $750,000 of that would be at risk in the event of a bank failure.
Although you can circumvent this by opening $250,000 accounts at different banks, that would certainly complicate your financial life. And by definition, you wouldn’t be stashing all your cash into your first choice. Every additional account would likely have features or benefits that were not quite as good as at your favorite bank.
Part of the reason you want to avoid putting too much money into a savings account is that it comes with a big opportunity cost. Any money you put into a savings account won’t be available to invest in alternatives that offer a higher potential return.
For example, even if you can find a savings account with a 4% yield, that’s a far cry from the long-term average return of the U.S. stock market, which is closer to 10% annually. Keep in mind that a savings account is best used as a place to keep your emergency fund and any other short-term cash that you need to be able to access immediately. It should not be the cornerstone of a long-term financial plan.
So, What’s the Magic Number?
As with most things in the investment world, there is no one number that is the right amount for everyone to keep in their savings account. However, many experts suggest that if you’re working a steady job, you should reserve about three to six months of living expenses in a savings account.
You might want to add to that if you are uncertain about your job security, such as if you are a freelancer or if you are retired. A savings account is also an appropriate vehicle if you are accumulating a down payment for a house or are saving for other short-term goals, such as a vacation. In these cases, you should modify the amount you keep in your savings account accordingly.
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