Having a safety net of savings – or an emergency fund – is a smart financial move, but that does not necessarily mean that you should hoard all your cash in your savings account. When you have a buffer in place, at a reasonable size, it is time to start investing.
What is a reasonable size buffer you might ask? That’s a great question, but unfortunately, there’s no straightforward answer. The annoying fact is that the answer is, ‘It depends’.
Contemplate all possible scenarios that might require a bit of cash quickly in your life. It can be anything from losing your job (and that means calculating how long it might take until you can secure an income again), to your car breaking down, your pet getting ill, or your washing machine breaking down on you. This is what you need a buffer for. For someone it might mean the equivalent of one month’s salary, for others it might mean six. It all depends on your income and expenses, but also on how much you can tweak your expenses if needed.
But once you have this buffer in place, it is time to ditch the savings account. The reason behind this is the fact that most savings accounts offer little to no interest. In normal times this is a problem, but with todays soaring inflation, it’s an even bigger one. Despite the surging interest rates (a tool to beat this increasing inflation) banks are slow at increasing the interest rates on savings accounts.
What is Inflation?A Big Mac Example
Inflation is the slow devaluation of a currency over time. Or, another common definition is that it’s the “slow increase of prices over time.” If you’ve ever felt like things just keep getting more expensive over time, that’s because they are. Let’s use the Big Mac Index as an example.
When McDonald’s first introduced Big Mac to the public it cost just 45 cents. Today, that same exact product will cost you around 5 USD. This is a price increase of more than 1000%. If you think about it long enough, it really doesn’t make any sense for McDonald’s to increase the price of a Big Mac at all, and especially not by 1000%.
Since the 1960s, McDonald’s has gotten exponentially more efficient. Today, it has more sophisticated methods for farming, transporting, fertilizing, communicating, and antibiotics to keep cows healthy. With all this advancement, McDonald’s should be able to produce more burgers at a lower cost to keep prices down. So why in the world is the average cost of a burger increasing?
The answer is inflation.
The Big Mac isn’t increasing in price. Your money is decreasing in value.
The rate of inflation depends on a handful of different factors. Usually, it’s around a manageable level of 2-3% per year. This is also the rate at which most global central banks want inflation to hover. However, the inflation rate today is 10% in the Eurozone, and 6.9% in Canada. In other words, your money is losing 10% of its value in Europe, and 6.9% in Canada each year. This means that if you saved EUR 10,000 ($10,000) last year, it’s only worth about EUR 9,000 ($9,310) today in terms of purchasing power. If this continues at the same rate, it will only be worth EUR 8,100 ($8,667.61) next year.
This brings us back to saving money.
Inflation + Low Interest Savings Account = Dangerous co*cktail
If you keep your money in a savings account, you are actually losing money each year in terms of purchasing power.
Your savings are basically earning close to 0% in interest. Meanwhile, inflation is driving the prices of everyday goods up by almost 10% (or 6.9%) each year at today’s rate. Therefore, you should not keep all your money in a savings account. Instead, you should invest your money in a place where it can grow, like the stock market. Ideally, it needs to grow at a rate higher than inflation.
But hold on a minute, global stock markets are down this year too – right?
The stock markets across the globe have indeed had a tough 2022, but if we look at the markets historically it all adds up. Morningstar’s Global Index has had an annual return of 8.2% in euro during the past 20 years, while Morningstar’s European Index shows an annual return of 6.5% during the same period.. The Morningstar Canada Index has had an annualized return of 8.8% for the past 10-years, the timeline for which we have the data.
That is well above the inflation target of 2%.
This does not mean the road will be straightforward, there will be bumps along the way, but in the long run it can help you beat the inflation monster.
FAQs
If you keep your money in a savings account, you are actually losing money each year in terms of purchasing power. Your savings are basically earning close to 0% in interest. Meanwhile, inflation is driving the prices of everyday goods up by almost 10% (or 6.9%) each year at today's rate.
Is it bad to leave money in a savings account? ›
The recommended amount of cash to keep in savings for emergencies is three to six months' worth of living expenses. If you have funds you won't need within the next five years, you may want to consider moving it out of savings and investing it.
Why shouldn't you keep all your money in a savings account? ›
So if you keep your retirement nest egg in a savings account, you might lose out on the higher returns you need to outpace inflation over time. Also, a savings account won't give you any sort of tax break on your money.
Should you keep cash in savings account? ›
It depends on your plans for the money you're putting aside and how soon you want to use it. Savings accounts and term deposits are convenient to stash cash, especially for something like an emergency fund or a short-term goal like a holiday – as you can access the money easily when you need it.
Why shouldn't you keep cash in the bank? ›
You could be taxed on interest. While we recommend you keep an emergency fund in an easy access savings account so you always have available cash should you need it, avoid holding more than you need. Generally, it's wise to have between three and six months net income for a “rainy day” fund.
How much cash is too much in savings? ›
FDIC and NCUA insurance limits
This insurance protects your money if the financial institution you bank with goes out of business or otherwise can't afford to let you withdraw your money. So, regardless of any other factors, you generally shouldn't keep more than $250,000 in any insured deposit account.
Is there a risk of losing money in a savings account? ›
Savings accounts are a safe place to keep your money. But watch out for fees, inflation rates, and a lack of FDIC insurance to ensure you don't lose any of your hard-earned cash.
Where do millionaires keep their money? ›
Cash equivalents are financial instruments that are almost as liquid as cash and are popular investments for millionaires. Examples of cash equivalents are money market mutual funds, certificates of deposit, commercial paper and Treasury bills. Some millionaires keep their cash in Treasury bills.
Do rich people keep their money in savings account? ›
Usually offering significantly more interest than a traditional savings account, high-yield savings accounts have blown up in popularity among everyone, including millionaires. Still, high net worth individuals tend to put the lion's share of their cash elsewhere.
Is $20,000 in savings good? ›
Is $20,000 a Good Amount of Savings? Having $20,000 in a savings account is a good starting point if you want to create a sizable emergency fund. When the occasional rainy day comes along, you'll be financially prepared for it. Of course, $20,000 may only go so far if you find yourself in an extreme situation.
Short-term savings goals: less than 2 years
Before you start investing for longer-term goals, it's important to have an emergency fund with around three to six months' worth of expenses. Keeping these in a checking, savings, or MMA is best because these accounts are liquid.
How much cash can you keep at home legally in the US? ›
While it is legal to keep as much as money as you want at home, the standard limit for cash that is covered under a standard home insurance policy is $200, according to the American Property Casualty Insurance Association.
What is the 50/30/20 rule? ›
The 50-30-20 rule is a common way to allocate the spending categories in your personal or household budget. The rule targets 50% of your after-tax income toward necessities, 30% toward things you don't need—but make life a little nicer—and the final 20% toward paying down debt and/or adding to your savings.
Is it smart to leave money in a savings account? ›
Any money you have earmarked for emergencies, or for near-term goals, like buying a car or home, should be kept in a savings account. But if you have money you're trying to save for long-term goals, like retirement, then investing it could really be a far more lucrative choice.
Can banks seize your money if the economy fails? ›
It indicates an expandable section or menu, or sometimes previous / next navigation options. Your money is safe in a bank, even during an economic decline like a recession. Up to $250,000 per depositor, per account ownership category, is protected by the FDIC or NCUA at a federally insured financial institution.
Why is it a bad idea to leave your idle cash in the bank? ›
Leaving a specific amount idle in your savings bank account for a long time, while may earn you some interest, also makes you miss the chance of generating higher returns if invested elsewhere.
Is it worth keeping money in a savings account? ›
For the emergency stash, most financial experts set an ambitious goal at the equivalent of six months of income. A regular savings account is "liquid." That is, your money is safe and you can access it at any time without a penalty and with no risk of a loss of your principal.
How much money should I leave in my savings account? ›
For savings, aim to keep three to six months' worth of expenses in a high-yield savings account, but note that any amount can be beneficial in a financial emergency. For checking, an ideal amount is generally one to two months' worth of living expenses plus a 30% buffer.
Will my money be safe in a savings account? ›
Most deposits in banks are insured dollar-for-dollar by the Federal Deposit Insurance Corp. This insurance covers your principal and any interest you're owed through the date of your bank's default up to $250,000 in combined total balances. You don't have to apply for FDIC insurance.
Should I keep $10,000 in savings? ›
First things first: There's nothing wrong with keeping $10,000 in a savings account. If you're working with a reputable bank, your money will have Federal Deposit Insurance Corporation (FDIC) insurance up to $250,000 per person per account ($500,000 for joint accounts). This protects your money even if the bank fails.
