Why High Savings Accounts Aren't Always Ideal: A Financial Strategy

A big savings account balance isn't a good thing for two key reasons.

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I have several different savings accounts that I use to put money aside for specific financial goals. For example, I use these accounts to save for emergencies or to save money to pay for vacations and home improvements in cash.

But I am very careful with how much money I invest in these savings accounts and I make sure not to put in more than is necessary to accomplish the short-term financial goals I've set for myself. Here's why.

Savings accounts don't provide a very good ROI

One big reason why I don't invest more than necessary in savings accounts is because even high-yield accounts pay a pretty small amount of interest.

It's rare these days to find an account that offers an annual percentage yield of even 1%. That means the interest you earn on those funds is negligible even if you have a large amount of money saved.

It's possible to earn a much higher rate of return with other investments that are relatively safe, such as an exchange-traded fund that tracks the performance of the S&P 500. That's a financial index made up of 500 very large U.S. companies that has, over many decades, produced average annual returns of around 10%.

I know that I need to accept a lower ROI by putting some money into savings accounts because there are times when it doesn't make sense to invest. If I'll need the money within a year or two, for example, I don't want to put it in the stock market because there's a chance there will be a downturn right when I need the cash. In this case, I might be forced to sell at a loss if I hadn't had much time to make a profit and don't have time to wait out the downturn.

But I don't want to limit my returns on investment any more than is necessary. So, I've figured out how much to save for emergencies, since I need to be able to access that money immediately if something goes wrong -- without worrying about my investments being down. And I've figured out exactly how much I need for short-term goals. And I put that amount in savings and nothing extra. That way, I have the cash I need when I need it -- but I'm maximizing my earning potential on the rest of my hard-earned funds.

The value of savings is reduced by inflation

Another big reason why I don't put more money than necessary in savings is because I understand that inflation will eat away at the buying power of any funds I've invested in a savings account.

See, the price of goods and services almost always goes up over time. In fact, the U.S. Central Bank (the Federal Reserve) has a target inflation rate of 2%. This means they generally set monetary policy with the goal of encouraging around a 2% year-over-year increase in overall costs of living.

If you have money invested in savings that earns 1% or less and the price of the things you buy goes up 2%, you've lost ground and the money in your account buys you less than it did when you put it in.

It's OK to accept this loss if there's a good reason to -- such as avoiding the risk of loss and making sure your funds are accessible. But unless you need to have your funds in a savings account, opening a brokerage account and investing the money is going to help you preserve your spending power and is likely to be the better financial move.