When you were a kid, you probably stashed any money you received for your birthday or from the tooth fairy in a piggy bank. Then, when you were old enough to have a summer job at the mall, you put those earnings in a savings account at the bank.
While that savings account was a good option when you were in your teens, it can be a less-than-desirable holding place for your cash reserves now that you’re an adult.
Granted, savings accounts are a great place to hold your emergency fund (which should cover at least six months’ worth of vital living expenses). “The money is liquid so you can get to it when you need it,” says Greg McBride, senior financial analyst at Bankrate, a financial information site. In other words, you won’t be penalized for withdrawing money at any time (unlike a CD).
Plus, by keeping your emergency funds in a savings account they won’t be affected by any negative fluctuations in the market—meaning that you won’t lose the money you deposited, even if a recession causes steep drops on Wall Street.
If you’re currently holding your emergency reserve in your checking account, now is a good time to move it to an account solely designated for those moments of crisis. Otherwise, you could accidentally spend the money on not-so-urgent things, like groceries or a new pair of shoes. (A savings account from an online bank is probably your best option, since they tend to pay the highest interest rates. To find the one currently earning the most, click here. )
But despite these positive attributes, savings accounts aren’t a good place to park any long-term savings (think: money set aside for retirement, college funds). Why?
POOR INTEREST RATES
The Federal Reserve has kept interest rates at all-time record lows for several years now. As a result, savings accounts pay very little—and in some cases, almost no—interest. (Current rates hover beneath 1 percent.) So money held in a savings account doesn’t maintain its buying power since any interest it earns does not keep pace with inflation, explains McBride.
NO TAX INCENTIVES
Funds that are held in retirement accounts, such as a 401(k), 403(b), or IRA, have the benefit of growing tax-free. But as McBride points out, any earnings that you make on money that’s held in a savings account will be taxed.
Granted, if you have a savings account with an online bank, you might be able to avoid a monthly maintenance charge. But if you’re keeping your money in a savings account at the nationwide bank that’s just down the street, it’s likely that you’ll get hit with a hefty charge—unless you hit specific requirements, such as maintaining a minimum balance of at least a couple hundred dollars or making recurring, automatic deposits into the account. (For example, Wells Fargo charges $5 each month for their basic savings account; Chase assesses a monthly $4 fee.)
Paying a fee that’s more than what you’re earning in interest doesn’t make much sense, does it?