There are three seemingly legitimate reasons someone might deposit money into a savings account: 1) as a quick location to keep cash for near-term use, 2) as a long-term location to keep cash for earning interest on the amount saved, or 3) as an easy way to separate money for different people and/or purposes, such as an emergency fund or college savings.
The problem with a savings account is that it is not the best choice for achieving any of the above objectives. Let's look at each objective individually and propose alternative choices.
1) A Savings Account is Not the Best Location to Keep Cash for Near-Term Use
A checking account should be used for this, not a savings account. A checking account provides for the use of checks and debit cards. You should always seek to minimize fees when choosing a bank for your checking account. Make sure you understand the requirements to avoid checking account fees which may often include account minimums or a certain frequency of deposits.
If you are charged a fee because you made a mistake such as overdrawing your account or failed to meet a minimum requirement, most banks will waive the fee if you make a simple phone call and explain the situation. Banks are competing fiercely for your business in today's market, so there is no reason you should be paying any fees for a checking account.
While we're on the subject of checking accounts, a common mistake many people make is keeping more money in a checking account than needed to pay upcoming bills. For example, if your average spending in a typical month is $4,000, there is no reason to hold more than $8,000 in your checking account. My personal rule of thumb is to target a checking account balance of whatever my monthly expenses are. This provides a 1-month safety buffer between my expenses and checking account balance. If I know I'll have a major expense in a given month, I'll plan accordingly and make sure my checking account has what it needs to cover the expense.
On the other hand, if my checking account ever reaches a balance of two months' worth of expenses, it's time to consider moving the additional amount to an appropriate investment account (more on that below).
2) A Savings Account is a Horrible Place to Save Money for Earning Interest
During the financial collapse of 2008, the vast majority of banks eliminated interest from their customers' savings account. Market interest rates tanked, so savings account interest rates followed. Interest rates have recovered since then, but savings account interest never came back (see image below). Banks realized that the interest rate on savings accounts wasn't actually a critical decision factor for most bank customers, existing or new. So they eliminated the rates and profited off people unwilling (or unaware) to change their banking habits.
For example, Bank of America's savings account rate is currently 0.01%. This is laughable by any standard, and arguably even predatory. Millions of customers everywhere in the world are essentially giving Bank of America (and many other banks) interest-free loans. A great business plan if you've got the customer base and lack of moral fortitude to pull it off.
Instead of keeping extra money in a typical savings account, you should deposit it into a brokerage account or high-yield savings account. High-yield savings accounts are created specifically for financially savvy savers who actually do care about earning interest. There are several online high-yield savings accounts that offer interest rates in the 1-1.5% range (let me google that for you).
A brokerage account is a great option if you want more options for investments and are willing to take a little bit of risk for greater returns. I'm a fan of brokerage services such as Robinhood and Betterment for savvy investors looking for quick and easy options to start investing. All of these options can be opened and funded online from the comfort of your own home, in less than half an hour.
3) There Are Better Methods of Separating Money for Different People and/or Purposes
There are dozens of different investment vehicles that offer incredible advantages for specific reasons that are vastly superior to bank savings accounts.
For example, a Roth IRA is a great place to keep your emergency savings in case of sudden loss of income or an unexpected, large expense. The reason a Roth IRA is great for emergency savings is that contributions can be withdrawn at any time, for any reason, without penalty. If you're lucky enough to never have to touch your Roth IRA emergency fund, you've just made a great contribution towards a tax-free retirement.
If you're saving for a child's future education fund, use an education-specific investment account such a 529 plan. In addition to growing faster through investments, your savings are magnified by even more tax advantages.
But what if there is no specific investment vehicle designed for your savings goal, such as saving for a vacation? A brokerage account with conservative investments or a high-yield savings account is still a better option. You'll be able to keep the cash separate from your checking account while earning a better interest rate, meaning you'll be able to go on that vacation sooner and enjoy more poolside manhattans.
Conclusion
At the end of the day, a savings account with little to no interest is practically useless when compared to the easily accessible options that exist today. If you can spare an hour or less, you can set yourself up with a savings account alternative that lets your money start working for you.
How do you feel about my assessment of savings accounts? Do you know of any good reasons that make a savings account useful? Feel free to comment below!
Interested in learning how to invest? I teach investment classes in the St. Louis area for beginners and hobbyists alike. The next half-day class is forming now. Sign up here
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