When saving might be costing you

There's a dirty little word in finance - one that wealthy people love and everyday individuals are taught to avoid. To the wealthy, it's the key to unlocking wealth and growth. To everyday individuals, it's the reason why the nextdoor neighbor's aunt's brother-in-law gambled away their retirement. 

R I S K

It's part of the reason it's expensive to be poor.

When there's a lived reality of scarcity, it's normal to shift towards a protectionary mode. In that mode, you're less likely to take bets. And even when you may no longer be experiencing actual scarcity, it's hard to pinpoint a moment when it's ok to start acting differently. If you're used to making ends meet, then suddenly start earning more... it's natural to instinctively think about saving money and making sure it's safe. 

But what happens when a growing number of today's adults are blowing well past reasonable emergency savings fund sizes, and still keeping money in a checking or savings account?

In today's blog post, we're going to discuss:

• The interest penalty that banks make billions on

• Why saving is not investing

• Why the 50/30/20 rule is holding people back

• The cost of saving well

• The 3 steps to start investing today

The interest penalty that banks make billions on

Since the start of 2019, everyday Americans have missed out on an estimated $42 billion in interest.... if you go further back in time, the number grows rapidly to a staggering $600+ billion (source: Wall Street Journal).

How is this possible?

It's the business of banking. Every day consumers deposit money into their bank accounts and earn a 0.08% national average for checking balances and 0.46% national average for savings balances as of Aug 2024. And while banking may drum up images of big vaults and piles of cash, your money rarely just sits at the bank.

Banks are allowed to use your deposits and loan over 90% of that out to other consumers of businesses.... that 8% loan on your car? It "cost" the bank the 0.46% they're paying you for your savings and they're making almost 7.5%. That business loan for 12%? That's potentially your deposit money going to make that loan possible.

Despite that, consumers often don't realize this and stick with the "big banks" because of convenience, inertia, and a feeling of safety (though FDIC + SIPC insurance often makes that moot for balances under $250k).

And when interest rates are at recent highs, consumers just get hit harder because the deposits barely earn more and the loan costs go up. As checking + saving account balances grow, the "cost" of saving grows with it.

Why saving is not investing

There's a reality that you can't invest if you don't save. There's literally not enough dollars left over for it. 

But just because you're saving, it doesn't mean it's being put to work well and being invested.... even if it's deposited in a high yield savings account. Interest rates are unusually high .... the fed funds rate has ranged from 0.12 - 5.33% ever since 2010. In contrast, the S&P 500 has averaged a 10.26% return over the past 66 years. The lower the interest rate, the more you're missing out when you save and don't invest.

When your money is in a savings or checkings account, it's sitting in a bank waiting for the bank to loan it out to make money. When your money is invested, it's being put into things like stocks or bonds. To give you a reason to put your money in, companies issuing stocks will aim to use your money to grow their business so your investment is worth more. For bonds, there's a promise of future payments (ie bonds).

In both of these cases, there is risk. But without taking the risk, you don't get the chance to earn more. 

Why the 50/30/20 rule is holding people back

The 50/30/20 budgeting method was popularized by Senator Elizabeth Warren and her daughter, Amelia Warren Tyagi, in their 2005 book All Your Worth: The Ultimate Lifetime Money Plan. This guideline splits your after-tax income into three buckets: 50% for needs, 30% for wants, and 20% for savings and paying off debt. It aimed to make it simple, especially for young millennials. 

While it's an important framework to start managing money, it misses the most critical part.

Saving, is not investing. 

And potentially, 30% for current you vs. 20% for future you (incl. debt), is not putting a lot away to help you reach a point where you never need to worry about money anymore.

The cost of saving well

Compounding is like the magical fairy dust that can turn a pumpkin into your Cinderella carriage... if you know how to put it to use.

Let's see how the numbers play out with three potential paths:

1. Leaving money in a basic savings account (currently 0.65% APY)

2. Leaving money in a high yield savings account (currently ~5% though historically much lower)

3. Investing in a S&P 500 (10.66% historically

When you put money into a savings account, all the money you earn is earned in "interest". What people commonly forget is that interest is taxed at a higher rate than investment gains usually are: interest is taxed like employment income... if you pay a 20% or a 40% rate, that's how much tax you have to pay on your interest. When you're taxed, you now have less money to keep growing and things grow more slowly.

When you invest, you're only taxed when you sell your investments. So if you don't sell, you're not taxed every year and there's more to grow year by year. As you start to play this out over longer time frames, putting $10k per year aside starts to look very different if you're investing vs. saving (and as a heads up, it's highly unlikely for high yield savings rates to stay at 5% and may start to drop as early as September). 

With investing, the gap just gets wider and wider.

The 3 steps to start investing today

If you're not sure how to start investing, it's easier now than it's ever been. Over the past 15 years, new companies called (robo-advisors) like Plenty have now made it as easy as saving. 

To get up and running with investing at Plenty, all you need to do is:

• Open an account

• Answer two questions about your comfort with investing

• Make your first deposit

• Then you're done! 

Sources

Rabouin, Dion. "The $42 Billion Question: Why Aren't Americans Ditching Big Banks?" The Wall Street Journal, 23 Aug. 2023, www.wsj.com/articles/the-42-billion-question-why-arent-americans-ditching-big-banks-11670472623.

Maverick, JB. "What Is the Average Annual Return of the S&P 500?" Investopedia, 3 Jan. 2024, www.investopedia.com/ask/answers/042415/what-average-annual-return-sp-500.asp.

Yale, Aly. "50/30/20 Budgeting Method." Fortune, 14 June 2024, www.fortune.com/recommends/banking/50-30-20-budgeting-method/.

Knueven, Liz, and Sophia Acevedo. "Average Interest Rates on Savings Accounts: A Comprehensive Guide" Business Insider. 21 Aug. 2024, www.businessinsider.com/personal-finance/banking/average-savings-account-interest-rate#:~:text=The%20national%20average%20interest%20rate,online%20banks%20pay%20much%20more.

Cooper, Jennifer. "Average Checking Account Interest Rates Of August 2024." Forbes Advisor. 20 Aug. 2024, www.forbes.com/advisor/banking/checking/average-checking-account-interest-rates/#:~:text=Interest%20checking%20accounts%20pay%20interest,account%20interest%20rate%20is%200.08%25.

About Plenty

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The hypothetical performance results discussed in this blog are based on historical rates. Such results do not reflect the outcomes of actual trading and have many inherent limitations.

The information provided herein is for general informational purposes only and should not be considered individualized recommendations or personalized investment advice. The type of strategies mentioned may not be suitable for everyone. Each investor should evaluate an investment strategy based on their unique circumstances before making any investment decisions.

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