The financial services industry is enormous. There are countless magazines, commercials, shows and blogs that talk about financial products and services (I do that also, but only with products I use and trust. Like Digit.)
Companies like Fidelity , Vanguard and Charles Schwab will talk about their mutual fund options all day long. Life insurance companies will be happy to show you their complex whole life insurance and annuity plans. If you turn on any business news channel, you’ll start believing that the world is going to end and you need to entrust your financial life to a specific company.
All of this marketing is designed to separate you from your money, and will ultimately enrich the companies in the form of fees and commissions, regardless of your own personal performance. Marketing is a powerful tool and the odds are stacked against the average consumer.
But what if I told you there is a financial product available that is virtually risk free and will give you great returns throughout your entire life? This product is not heavily advertised in the financial world and will only get a cursory mention by financial advisers.
That product is the humble emergency savings account.
Savings account? Really?
Yes really. And it has nothing to do with the interest rate.
Most people have savings accounts and don’t even know it. Many banks sign you up for one when you get their checking account, although most people don’t give it a second thought. But they can be a powerful wealth building tool. How can that be when the interest rates are so low?
A savings account with Bank of America will get you a maximum interest rate of .03% That’s right, 3 hundreths of a percent. Almost nothing.
An online savings account with Ally, which I currently use, gives a 1% interest rate. A LOT higher compared to a Bank of America account, but still not too high in the grand scheme of things.
(By the way, sign up for an online savings account if you don’t have one. You’re just leaving money on the table if you don’t)
The beauty of a savings account doesn’t lie in the interest rate. Savings accounts are awesome because they can enhance your financial life by providing positive returns in so many ways. Here are some examples:
Higher deductibles: Insurance is a game of risk. This is true for any type of insurance, including health, auto and homeowners. If you take on more risk, you pay less in premiums to the insurance company. If you take on less risk, you pay more in premiums.
Assuming coverage remains the same, the best way to take on more risk, and thus decrease your premiums, is by increasing your deductible. This will be how much you pay out of pocket before the insurance company starts paying. The higher deductible you pay, the lower premiums you pay.
What a large savings account does is that it allows you to set a higher deductible because you will be able to cover that deductible payment if need be. I believe the role of insurance is to help you out in catastrophic cases, such as a car accident or major illness. In the case of a car accident, having a low $100 deductible is not really a big benefit since the cost of replacing a car can run well into the tens of thousands.
For example, I have car insurance with Geico. If I choose a $1,000 deductible on one of my cars, which is an amount any decent savings account should have, my 6 month premium is $285. Not bad at all. If I leave the coverage the same and change the deductible amount to $100, the 6 month premium jumps to $395.
An extra $110 for 6 months is not bad, but if you have a large savings account, there is no need to spend that extra money. Apply this principle to all your cars and all of your various insurances (especially your health plan), and you can easily save hundreds of dollars per month just for having money in a savings account to cover those deductible payments.
Bulk Purchases: This is an easy one. Buying in bulk is almost always cheaper than not, especially with groceries. And having money in the bank allows you to do this anytime you want.
If you see something you regularly purchase on sale at the grocery store for half off, you can save a lot of money by buying enough of that item to last you for the month instead of coming back every week and paying the regular price again.
Your savings account just helped you slash your grocery bill.
Pay in cash: With things like cars, home repairs, remodeling and appliances, most people just assume you have to take out a loan. That’s just how things are done. But not if you have cash in your savings account.
We recently got an estimate for a painting job from a number of contractors. All the estimates were for about $1,000. Since I will be paying in cash, this will be an easy transaction. Just transfer from my savings account and pay the contractor.
Most people go would go the loan route. A good rate for a personal loan would be 6%. If I could get a 6% loan with a 5 year term, the monthly payment would be $19.33. What a steal!
Actually, not a steal at all. The extra interest you would pay over the 5 years would be $159.97. So having a savings account that could cover that amount right off the bat will save me $160 compared to having to take out a loan.
Leave investments alone: This is where having a savings account can potentially help you keep a whole lot of your money. Everyone needs to invest whatever they can as early as they can. Compounding interest early in life produces great returns later. This has been proven extensively.
But what if you have been investing so much that you totally neglect your savings account and now you owe someone $5,000? You’re going to have to tap your investments which is going to cost you in 2 ways: Transaction costs and diminished investment returns.
If you have to withdraw from a retirement account, add a penalty payment and extra income tax on top of that. And all the while you are missing out on returns your $5,000 could have been getting if it remained invested. Not a good situation.
So even if you’re the most gung-ho investor and you’re super excited to get in the game, make sure to set aside some cash just in case. It will actually help you keep more of your money.
With all the savings to be had from higher deductibles, bulk purchases, not having to get a personal loan or withdraw from your investments, I hope you’re convinced that having cash set aside in a savings account is a good idea.
I hear many people rail against savings accounts because of the low interest rates and how the “opportunity cost” is too high since you could be getting a higher rate of return elsewhere. But no other account allows you to withdraw money as needed and gives you the peace of mind found in all the previous examples.
So help keep your financial house in order and open an online savings account. Make sure to keep replenishing it because it is not a matter of if you’ll need it, but when you’ll need it.