No matter your income or stage of life, you need money set aside in the bank for emergencies. Ideally, your emergency fund should contain enough cash to cover three full months of essential expenses at a minimum. But while it's a good idea to keep emergency cash in a savings account, here are three scenarios where it's best to stash your money elsewhere.
1. It's for retirement
The money you're setting aside for retirement should be kept outside of a savings account for a couple of reasons. First, you need your money to grow at a faster pace than what a savings account will allow for. Right now, many high-yield savings accounts are paying somewhere in the vicinity of 4% to 4.5%, but today's rates are unusual. Historically, they've been lower on many occasions.
What's more, while a risk-free 4% or 4.5% return on your money may be nice, the stock market's average return over the past 50 years, as measured by the S&P 500, has been 10% before inflation. So if you keep your retirement nest egg in a savings account, you might lose out on the higher returns you need to outpace inflation over time.
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Also, a savings account won't give you any sort of tax break on your money. The interest you earn on your money will be taxed at the same rate as ordinary income -- the highest rate you're subject to. A better bet is to save for retirement in an account like an IRA, where your contributions go in tax-free.
2. It's for college
Just as you need your retirement savings to grow at a pretty rapid rate, so too do you need to see your college savings take off nicely. With retirement, you might have a 40-year window or longer to save. With college, you may be limited to an 18-year window if you want your kids to start as soon as they graduate high school.
There are different accounts you can use to save for college. But if you want to enjoy some tax savings, you may want to consider a Roth IRA or a 529 plan. Both of these accounts allow for tax-free investment gains, and withdrawals are tax-free as well (in the case of a 529, tax-free withdrawals only apply to qualified educational expenses).
3. It's for a really far-off goal
Generally, it's not the best idea to invest money you expect to need within seven years. It might take the stock market a long time to recover from an extended slump, so if you're saving for a near-term goal, keeping your money in the bank is generally a smarter bet.
But if you're saving for a far-off goal, like buying a second house, and you don't expect to reach that goal for a good 10 to 15 years, then investing your money could get you closer to meeting that objective. And in that case, you're better off keeping that money in a brokerage account.
A savings account is a great home for your emergency fund. And if you're socking away money to pay for holiday gifts in December or take a vacation at the start of 2024, then a savings account is probably your most optimal choice. But if you're saving for retirement, college, or another far-off goal, then it's best to put your money to work by investing it, even if that means forgoing the safety of a savings account.
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