One of the great aspects of savings accounts is that they provide a secure spot to store your cash while allowing full access to your funds whenever needed. If you suddenly decide to withdraw $500 for an impromptu trip, you won’t face penalties—unlike when you pull out money early from a certificate of deposit, where such actions can result in fees before maturity.
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Certainly, you might not make as much money with a savings account compared to what a CD pays you However, the option to withdraw funds anytime might make up for the reduced interest rate.
If you look around for an excellent high-yield savings account, the annual percentage yield might match what a certificate of deposit offers you. Tap here to view the top-saving accounts and their current interest rates offered today. .
However, it's crucial to determine how much funds should be allocated to your savings account. Below is a guide on calculating this amount.
Determine your requirements for an emergency savings fund.
Your savings account is ideal for storing your emergency fund — funds set aside for unforeseen costs or times when you might be out of work (an unfortunate situation that can affect anyone). Experts in finance typically suggest maintaining an emergency reserve that covers between three to six months' worth of basic living expenses.
The choice between aiming for the lower end or the higher end of that range should be based on factors specific to your circumstances, like being the sole breadwinner in your home or having dependents. You might also choose to adjust accordingly depending on your particular situation. beyond The suggestion for a six-month notice period, which is sensible if, for instance, your role is highly specialized and difficult to substitute during layoffs.
However, after determining how many months’ worth of costs you desire to have set aside for emergencies, review your monthly expenditures to identify your essential spending. Should you typically shell out $3,000 each month on necessities like rent, utilities, commuting, and groceries, then opting for a half-year buffer would mean targeting an accumulated sum of around $18,000 tucked away in your savings account.
Check if you have any short-term financial objectives in sight.
You might have funds allocated for particular objectives, such as purchasing a newer vehicle. Additionally, cash you anticipate needing soon could remain in a savings account. Under certain circumstances, you might feel comfortable placing this money into a certificate of deposit (CD) if you’re sure about your timeline.
But a savings account is an even safer option in case you wind up needing your money sooner than expected. That way, you don't risk an early withdrawal penalty.
Don't go overboard with your savings account
Having insufficient funds in your savings account isn’t ideal. However, having an excessive amount of money saved up also comes with its own set of issues. much money, either.
While savings accounts still pay pretty generously these days, rates could fall in the coming months as the Federal Reserve cuts interest rates. And even if that somehow doesn't happen, over the past 50 years, the S&P 500's average annual return has been 10%, accounting for periods when stocks did well and periods when they tanked. So even if you keep getting around 4% from your savings account over time, that return might pale in comparison to what a stock portfolio pays you.
Suppose you maintain an additional $5,000 in your savings account above what you require for emergencies and short-term objectives. With a yearly interest rate of 4%, this amount could expand to roughly $11,000 within two decades.
However, with an annual return of 10%, you would end up with roughly $33,600. This represents a discrepancy of more than $22,000. If your savings account is overfunded, consider opening a brokerage account and start investing as soon as possible.
Savings accounts offer the benefit of flexibility without taking on the same risks you do with a stock portfolio (though to be clear, investing over a long period can help lower the risk of losing money). But it's important to get your balance just right. That means you don't want it to be so low that you're not properly protected against emergencies. But you also don't want to keep too much extra money in there, since that could mean losing out on much higher returns in the long run.
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