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The stock market can seem like a scary places.
After all, volatility is not only possible, but actually expected as the months and years roll by. As an example, the was down 19.44% in 2022 after increasing 26.89% in 2021. And so far in 2023, the S&P 500 is up again — around 14% as of this writing, give or take.
Watching your wealth increase and drop with these dramatic swings isn't for the faint of heart, which is why many investors seem to be drawn to high-yield savings accounts and certificates of deposit (CDs) right now. You can earn a fixed rate up to 7% with some of the top savings products at the moment, with minimal or fees and no worries over losing your nest egg to boot.
But, there are downsides that come with sitting on the sidelines when it comes to stock market investing and sticking with "safe" accounts like savings accounts and CDs instead. We reached out to financial advisors to find out their thoughts on storing cash in savings instead of investing, and here's what they said.
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Inflation can eat away at savings gains
Financial advisor Jeff Rose of Good Financial Cents says high-yield savings accounts and certificates of deposit offer some safety and predictability, but they shouldn't dominate a person's retirement portfolio. Instead, allocating a portion of retirement to "safe" accounts makes a lot more sense.
Rose adds that relying too heavily on these tools might backfire in the long-term, mostly because the potential growth and returns from diversified investments in the stock market, real estate or other avenues often surpass those of HYSAs and CDs.
He also refers to inflation as the "silent killer of the savings world."
"Park your money in a savings account or CD, and you'll watch inflation chip away at its real value," he said. "And while you're getting that guaranteed 5%, you're missing the stock market's enticing allure, which has historically promised — and delivered — a far more substantial return."
Watch out for opportunity cost
Financial professional Mike Villar of Empower says that, during higher interest rates environments like we're in now, investors tend to flock toward safe products like savings accounts and CDs because their initial deposits are protected from shifts in the market yet they still earn a fixed interest rate.
That said, the opportunity cost of keeping money in these vehicles could be extremely costly to your wallet and financial plans, he said.
"Locking your money up in a CD for a few basis points more can be considerably costly in the event you find a great investment opportunity, or we experience a rebound in the market and you'd like to participate in it," he says.
He adds that the risks are especially great when you're locking up your cash in a CD for a full term — sometimes a matter of years. Villar uses the example of CD rates from a year ago, which were around 3.5% for a 48-month CD. While that seemed good at the time, that rate would be well below market now and you would still have several years remaining on the CD's term.
You can always pay a penalty to cash out your CD (unless you're using a no-penalty CD), but that's another area where you're losing some of your gains instead of watching your money grow.
Don't forget tax considerations
Financial advisor John Grace of Investor's Advantage Corporation adds that you have to keep tax considerations in mind as well, including the fact that interest earned on savings accounts and CDs is generally subject to income tax in the year you earn it. In the meantime, some investment gains in the stock market could have more favorable tax treatment.
For example, upping your contributions to a tax-advantaged retirement plan like a 401(k) instead of stashing away extra cash in savings can help you avoid income taxes on amounts added in the year you contribute. From there, your money gets to grow tax-free until retirement age, at which point you pay income taxes on distributions you take.
It's smart to have some cash savings
With these risks in mind, there are definitely situations where storing money in a high-yield savings account or CD makes a lot of sense. For example, financial planner Walter Russell of Russell & Company says a well-rounded portfolio usually includes a mix of asset classes to balance risk and potential reward.
Further, consumers can use high-yield savings accounts and CDs as part of their investment strategy to hold their emergency funds, short-term savings and risk-free investments.
"Because these funds need to be liquid, you should have access to those funds immediately," said Russell.
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Freelance Writer
Holly Johnson is a credit card expert, award-winning writer, and mother of two who is obsessed with frugality, budgeting, and travel. In addition to serving as contributing editor for The Simple Dollar and writing for publications such as Bankrate, U.S. News and World Report Travel, and Travel Pulse, Johnson ownsClub Thriftyand is the co-author of "Zero Down Your Debt: Reclaim Your Income and Build a Life You’ll Love."
