Think “ordinary” cash savings isn’t part of long-term financial planning? Think again. Here are five things to know.
- What is it? It’s cash. It’s the liquid asset that we put in a money-market account or a CD at a bank that offers FDIC insurance (or its equivalent, such NCUA for credit unions).* It’s not in your mattress, in the cookie jar, or in the freezer. (There is probably only limited insurance coverage on your homeowner's policy!) It’s not invested. It’s not spent. It’s there for emergencies, for crises, for rainy days.
- Everyone needs savings. Your savings account should be able to sustain your household if you lose your primary source of income—anywhere from 3 to 9 months, maybe more. Why? What happens if you lose your job and are unable to find another one? What about a health crisis? Or you suddenly have to take care of a loved one? How do you go about saving this amount of money? Be consistent. Pay yourself first.
- Expect very little earnings. In today’s low-interest rate environment, do not expect to receive substantial interest from your savings account. The result is that the account will only grow substantially when you make contributions.
- Cash savings allows your financial plan to stay on track. In the case of an emergency (…you need a new roof—right before the rainy season) you will not have to disrupt your investment strategy to get the funds you need. The result is that your investment plan remains in place. There is no need to raid your investment accounts, especially during a down market.
- Inappropriate for Retirement Accounts Retirement accounts are an opportunity to grow your wealth. Your 401(k), 403(b), IRA or SEP should be invested in a mix of market securities that match your risk tolerance and time horizon. Retirement accounts should not be viewed as savings accounts: unless you are over 59½, there is a penalty for withdrawal, and all withdrawals are taxed as ordinary income. Use your retirement account to help accumulate assets for living expenses during retirement.
*For FDIC insurance, the standard deposit insurance amount is $250,000 per depositor, per insured bank, for each account ownership category. For NCUA insurance, $250,000 in coverage applies to each share owner, per insured credit union, for each account ownership category.