Savings accounts can have a poor reputation because they have such low returns, particularly in today’s economic climate. It’s true when taking inflation into account, you can actually lose money on a savings account in the long run. The Federal Reserve has not been kind to savers, especially since the financial crisis when the Fed dropped the interest rate to a historic low. But even in the current American economy, saving has some distinct advantages over investing.
“An average saver will do better than a great investor who doesn’t save,” certified financial planner David A. Schneider told Bankrate. The two strategies work well together, but without saving, investing would not be possible. Although investing will likely get you higher returns in the long run, this might not be your primary financial goal. It all depends on the context of your finances, where you are in life, and what’s important to you. Here are five times when it’s smarter to prioritize saving.
1. When you’re in debt
If you’re in major debt, investing should definitely not be your priority. First, you want to get rid of that debt, whether it’s for medical bills, credit cards, education, etc. The Securities and Exchange Commission recommends paying off all debts before both saving and investing. But if your only debt is, for example, a student loan or car payment that you have under control, saving might still be a good idea.
Because it is so pervasive, credit card debt should not be ignored. But as long as you are still able to make student-loan payments on time, it’s worthwhile to build up an emergency savings account before paying off the full balance on your loan, despite the interest that will build up. If paying off all of your debts and loans at once would put you in place where you couldn’t afford the next big expense that comes along, you might just end up in debt all over again.
2. When you don’t have an emergency fund
Some people caution against putting too much money into a savings account for emergencies because of the losses associated with inflation. But no emergency fund at all would be much more costly. According to The Cheat Sheet’s guide to saving, your priorities for optimal financial security should be as follows:
- Emergency fund (one month of expenses)
- 401(k) with company match
- Credit card balances
- Larger emergency fund (three to nine months of expenses)
The only investment that trumps saving is a 401(k) that offers an employee match, as this is essentially free money to put toward your retirement. Otherwise, a substantial emergency fund should be your priority, especially if you have dependents or variable income. A mere 38% of Americans have enough money in their savings to pay for surprise expenses, such as a $500 car repair or $1,000 emergency room visit. An unexpected job loss could do even more damage if you don’t have adequate savings.
3. When you want to prepare for big expenses
The primary advantage of savings accounts over investments is access. That’s the trade-off when it comes to returns. There may be certain penalties associated with withdrawing money from an investment account, but money in a savings account is essentially there for you whenever you need it. Federal law allows no more than six withdrawals per month from savings accounts, which should be plenty if you are reserving those withdrawals for large or unexpected expenses.
Even when it’s not necessarily an emergency, there are times when it’s wise to have money set aside for both expected and unexpected expenses. You can count on the fact that moderate car repairs and medical bills will crop up, and you might want to put money aside for planned expenses, as well. Here’s a general rule to follow: Save for short-term goals, and invest for long-term goals. You’ll want to save for a new car or an upcoming down payment on a house, for example, but your retirement or a child’s education 10 to 15 years down the road might warrant investing.
4. After a recent financial crisis
You’ve likely cleaned out your emergency savings fund after a financial crisis, so you’ll need to work on replenishing your stash. It will be important to replace the money you used to bridge the gap during a financial crisis. Although financial experts recommend saving at least 10% of your take-home pay, this might not be possible after experiencing a financial setback. Give yourself time to recover, and start slowly saving money by setting aside what you can until you get back on your feet. Even if you can only put away $20 a week, it’s a start. Don’t let your financial fears prevent you from saving money.
5. After a major life event
Did you just welcome a new baby? Did you get divorced or married? Major life events can be exciting. However, depending on the event, they can also be a huge money drain. If you’ve recently experienced a life change, it’s smart to be saving money for related short-term expenses. For example, after the birth of a child, you’ll want to have additional money for unexpected medical visits, diapers, and other incidentals. If you’re having a hard time saving enough cash after a big life change, don’t be too shy to ask friends and family for contributions.
Additional reporting by Sheiresa Ngo.