Yes, You Can Have Too Much Money
I’ve always believed that cash is truly king; after all, it’s important to have an easily accessible emergency fund to cover unexpected expenses. However, having excess cash on top of these six to nine months of expenses can mean losing significant profits. I previously recommended splitting your money into multiple accounts so you can see all your savings goals separately, making them easier to track and access for different reasons. Money set aside for emergencies goes into a different account than your dream vacation fund, and so on. And when it comes to anything beyond spending a few months, it’s more about understanding the opportunity cost of holding too much cash.
Don’t miss out on challenging growth opportunities
The power of compound growth is one of the most important principles of investing. When you leave money in cash, it does not grow at the same rate as if that money were invested in the stock market or other assets. Over time, this lost growth can really add up.
For example, let’s say you have $50,000 saved for a down payment on a home you plan to buy in two to three years. If you keep that money in a savings account earning 1% interest, it will grow to about $51,500 after three years. However, if you had invested that $50,000 in a stock index fund that returned an average of 7% per year, it would have grown to more than $56,000—a difference of almost $5,000. That’s a lot of potential growth that you’ll be missing out on.
Even if you don’t invest your money, you’ll still miss out on growth opportunities if you only save in cash. Think of it this way: if you put $500 into a regular savings account, you’ll earn $0.50 in interest for the year. With a high-yield account with a 2% annual interest rate, you’ll earn $10 on that $500, and more time and money means more interest.
The key is to think about your time horizon. If you have money that you know you’ll need in the next two to three years, such as for a down payment, car purchase or other large expense, it makes sense to keep it in a relatively stable, low-risk cash account. . On that front: here’s our guide to choosing a high-yield savings account .
When to choose investing or saving
Opt for low-risk cash accounts to save money you may need at any time over the next five years. Perhaps you have your sights set on a vacation or a down payment on a home, or perhaps you need to boost your emergency fund.
For long-term savings and investments, it’s usually better to use that money in the market, where it can accumulate and grow over time. So, while savings accounts are a choice as a short-term option, you can turn to investing to achieve your long-term goals, such as saving for retirement or paying for your children’s college tuition.
Bottom line
I get it: When you’re focusing on your day-to-day finances, it’s all too easy to let your investments or savings fall by the wayside. However, the ideal approach is to have a healthy emergency fund in cash and then invest any extra money beyond that. This allows you to earn higher profits while maintaining sufficient liquidity. It just takes some planning to determine how much money you actually need and how much you can afford to invest in the long term.