The Hidden Danger of Putting All Your Money in Savings

Many savings accounts pay favorable interest rates these days. Finding a bank that will pay you a 4% annual percentage yield (APY) or higher is relatively easy.

That's great news if you're opening a savings account, but there's one thing you need to be cautious about: Keeping too much money in your savings account. Here's why storing too much cash in savings can be a bad idea, and why putting most of your money in a brokerage account is a much better financial move.

What savings accounts are best for

Generally speaking, there are two valuable ways to use a savings account:

• Near-term spending: This would be money you plan to use sometime in the next three years. It may include money you're saving toward a down payment on a car, an annual vacation, or cash you're putting aside for your wedding.
• Emergency savings: This is money that you've saved to cover unexpected expenses, like fixing your car, replacing a broken appliance, or a home repair. You should start with a goal of saving $1,000 and then eventually build that amount up to three to six months' worth of expenses.

Why you shouldn't have all your money in a savings account

While many savings accounts pay high yield these days, they're still not paying enough to generate long-term wealth. If you want your money to grow significantly, you need to invest it -- here's why.

1. You can earn way more by investing

Let's take the average historical rate of return of 10% for the S&P 500 and see just how much money you can make from the market compared to keeping it in a savings account.

If you have $10,000 in a savings account that pays you a 4.50% APY and you add $100 every month for 10 years, you'll end up with about $30,577. That might seem like a pretty good return until you see how much you could have earned if you invested that money.

If you take the same $10,000 and buy a low-cost index fund that tracks the S&P 500, add an extra $100 per month, and earn the historic rate of return of 10%, you'll end up with $45,062. That means investing your money would make you about $15,000 more over 10 years -- without you having to do anything!

And if we use this same scenario over 20 years, the money invested in the index fund turns into $136,000 -- while the savings account money is just $62,533!

2. Investment accounts have more tax advantages

Putting your money into an investment account often gives you tax advantages you can't get with savings accounts. The type of advantages depend on whether you have a regular individual retirement account (IRA) or a Roth IRA.

Just for reference, in 2024, you can put up to $7,000 into your IRA account (regardless of whether it's a traditional or Roth IRA) or $8,000 if you're 50 or older.

If you have a traditional IRA, you may be able to deduct some or all of your contributions from your taxable income. For example, if you contribute $7,000 to a traditional IRA this year, you may be able to reduce your adjustable gross income (AGI) by $7,000, thus lowering your taxable income. The drawback to a traditional IRA is that you have to pay taxes on your account distributions in retirement.

For a Roth IRA, you don't receive a tax advantage in the year you make your contributions. So, if you contribute $7,000 to your Roth IRA, it will not reduce your AGI. Instead, you get to withdraw money from your account tax free in retirement, a potentially significant tax savings at a time when you may have limited income.

Whether you choose a tax-advantaged investment account or not, investing your money is one of the best ways to ensure you reach your financial goals. And with so many free stock investing apps available, getting started is easy.