Savings accounts are still an important part of your financial plan, even in a low-rate environment
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There’s much to be uncertain about these days, and that has trickled down to the way we handle and invest our money.
The savings account has always been a time-tested standby, an easy and accessible vehicle to park your extra money for future needs. While COVID-19 continues to leave economic uncertainty in its wake, more people are looking to this old favorite account to stash their cash, but is it the right move to make in a low interest rate environment?
“Interest rates are at historic lows and are expected to remain low for some time,” says Jay Abolofia, founder of Lyon Financial Planning outside Boston and a certified financial planner. “In general, this is good for borrowers and bad for savers.”
Savings account rates are very low
The pandemic is one of the primary drivers of the declining rate environment. In response to the economic fallout, the Federal Reserve in March 2020 cut interest rates to near zero.
“Although this has benefited the economy in many ways, it has also led many banks to reduce interest rates for savers,” says Chris Abrams, the founder of Abrams Insurance Solutions, an independent insurance and financial services company.
Throughout 2020, savings yields steadily declined, although they’ve largely stabilized. The best savings accounts currently pay around 0.6 percent APY, while the national average is just 0.06 percent.
So, why would anyone consider a savings account in such a climate?
“Even with rates so low, a bank savings account can serve a critical role in your overall cash management strategy, primarily because of their liquidity and deposit insurance,” Abolofia says.
Best uses for a savings account — even in a low-rate environment
A savings account can be the vehicle you need in some unexpected life situations. However, there might be other accounts to consider for certain goals or time horizons.
“Having a solid emergency fund will help you avoid a situation where you need to sell stocks that have dropped in value to pay for unexpected expenses,” says Scott Schleicher, senior financial advisor at Personal Capital. “A common rule of thumb is to save between three and six months’ worth of non-discretionary living expenses in an emergency fund. This includes expenses like your mortgage or rent, utilities, insurance, groceries and transportation.”
Here are a few other uses for a savings account.
When you need fast and easy access to the money
When it comes to withdrawing your money, savings accounts can make it easier than other products.
You can withdraw money from your savings account without paying a penalty fee, unlike a CD. This feature is especially important when it comes to unexpected emergencies. A savings account gives you convenient access to money for a new car tire or to pay for a similar emergency.
Even though the Federal Reserve deleted a rule that limited savings account withdrawals and transfer to six per monthly statement cycle, your bank may still have this rule.
When you need a place for short-term savings goals
The decision to use a savings account instead of another investment vehicle will likely come down to when you’ll need this money, says Gilles Hudelot, director of education for the Mentoro Group, a financial wellness education firm.
“Anything that might be needed in one to two years would be in the short-term bucket,” Hudelot says. “This includes emergency funds and short-term savings goals such as Christmas, vacation savings or expenditures you know are coming soon. The risk of that money going down in an investment account doesn’t outweigh the possible gains you might get.”
When you need a place to keep your money safe
As long as you bank with an FDIC-insured bank or NCUSIF-insured credit union, you have more protection than you have with other investments. They are backed by the full faith and credit of the U.S. government. The government will cover up to $250,000 for failures. Always make sure you’re within FDIC or NCUSIF limits and guidelines.
Situations when a savings account doesn’t make sense
Even with all of its benefits, a savings account is not for every scenario.
When you need a place for long-term savings goals
Consider strategies that will help you earn more money over time, like investing it. Savings accounts are excellent for your short-term savings or emergency fund.
When you don’t meet the account’s minimum balance requirement
You’ll need to meet the account’s minimum balance requirements for it to be right for you.
“Most savings accounts today will have a minimum balance requirement, which means if the account balance falls below the minimum amount, the account will incur charges or fees, which can rob your account of its interest rate that (it’s) earning,” says Juan Carlos Cruz, founder of Britewater Financial Group in Brooklyn, New York. “Use of a savings account for the purpose of retirement and that low interest rate may not help keep up with inflation.”
When you’re looking for big returns
A savings account won’t be the right fit for every situation.
“If you’re looking to save for any future financial goal, there are a lot of better options to maximize your money,” says Jacob Dayan, CEO and co-founder of Community Tax. Bonds, CDs, Treasury bills and notes best suit the risk-averse. For those who can take on more risk, there are great options such as index funds and blue-chip stocks. These options are much better suited than a savings account where you can put your money to work and earn higher returns.”
A savings account may not be ideal for every situation, such as saving for retirement. Savings accounts, however, can be a fantastic tool in your financial arsenal when you need short-term savings close-by and secure.
“Savings accounts are like parachutes,” says Roy Ferman, Founder and CEO of Seek Capital. “Your finances might end up in a free-fall whether it is from debt, loss of income, or a life-threatening virus that stopped the world. A savings account will serve the purpose of catching your fall.”