Many believe that boosting your bank account by stuffing it with savings is smart. However, is it possible to actually save too much money?
It can be if you are great at saving money but haven’t thought about investing any of that cash in the stock market.
There are several reasons why you might be better off investing some of your cash. Following are a few reasons to consider moving some funds off the sidelines and into the stock market.
Savings account returns might not keep up with inflation
Inflation has been sky-high over the past few years. While the rate of inflation is down a bit lately, prices remain elevated. That makes it difficult for money in savings accounts to keep pace with inflation.
When prices started rising a couple of years ago, the average savings account rate was near 0%. It is possible to find significantly higher rates on savings today, but you still generally receive returns below the inflation rate.
That means dollars sitting in savings accounts can simply lose value the longer they remain in those accounts.
Investing money in the stock market comes with risks — you might lose money, or you might make money. But the upside on investing in stocks is often higher than the upside of returns in a savings account.
Stocks historically have delivered higher returns than savings accounts
As mentioned above, the stock market historically has provided higher returns on investments than what people have received on the money they park in savings accounts.
Now, you need to remember that past returns are no guarantee of how stocks will perform in the future. Nobody can promise that you will make money by investing in the stock market. In fact, plenty of investors lose money on the stocks they purchase.
However, as the U.S. Securities and Exchange Commission flatly states, "Over many decades, the investment that has provided the highest average rate of return has been stocks."
You can get a 401(k) match from your employer
One of the best investment returns workers can get on their money is the match that some employers offer on contributions to a 401(k) or similar retirement plan.
Many employers offer a “company match” on employee contributions. For example, they might match half or all of the contribution you make to a retirement plan up to a specific percentage of your salary.
In essence, this is “free money.” There is no risk to you in accepting this matching contribution.
What you decide to do with that money is up to you. Perhaps you plan to invest it in stocks. Or, you could put the money into something safer, such as a stable-value fund.
Just remember that you need to contribute to a 401(k) or other retirement plan in the first place to be eligible for the match.
Long-term capital gains can be more favorably taxed than ordinary income
If you keep a large sum in your savings account, you might earn some interest on the money. This income is taxed at your ordinary income tax rate.
By contrast, the profits you earn from investing in stocks are considered to be “capital gains.” If you invest in a stock and sell it to cash in on your gains within a year, it’s considered to be a “short-term capital gain.” In such situations, the capital gain is taxed at ordinary income rates.
However, if you hold the investment for more than a year before selling, the gains are classified as “long-term capital gains” and generally are taxed at lower rates that are based on your income.
The long-term capital gain rate can go as high as 28%, but is “no higher than 15% for most individuals,” according to the IRS. That means many people can pay a lower tax on their long-term capital gains than they pay on income they earn in a savings account.
You already have an emergency fund that can cover most disasters
A disaster can strike at any moment. A pipe can burst in your home or you can suddenly lose your job, for example.
For this reason, it is typically wise to keep money in a savings account that you can tap to cover such emergencies. Many experts recommend keeping three to six months of expenses in such an “emergency fund.”
It can be risky to invest money in the stock market if you do not have an emergency fund. But if you have saved up enough for such a fund, you might be in a good place to consider moving some of your extra savings into investments.
You have a high income, with plenty of money left after paying expenses
Some folks are fortunate enough to have a large income and a wide margin between how much they take home and their monthly expenses.
If you are among them, you might be more comfortable taking some of that excess money and investing in the stock market.
Your income takes care of your bills and then some, so you might consider putting some money to work in hopes of building wealth.
You want to retire early
Millions of people plan to retire early. In some ways, it is the new American dream.
But achieving this goal is difficult if you do not find ways to grow your savings. As the SEC reminds us, historically, investing in stocks has provided some of the best returns available to anyone trying to build wealth.
Many people who dream of retiring early invest their cash in stocks and then give the investments time to grow so that they can fund their lifestyle in retirement.
If you want to retire early, saving a lot of money — and possibly investing at least some of it — might help you move toward that goal.
If you want to retire someday, avoiding investing might not be the best option.
Investing in stocks definitely involves some risk. Many people lose money in the stock market. But in the past, millions of others have successfully used investing in stocks as a way to build wealth.
If you’ve already put away money for emergencies and have a lot of extra savings, you might want to consider opening a brokerage or IRA account, or contributing more to your 401(k).
If you are unsure of the best path forward, consider meeting with a professional financial advisor who can offer guidance.