Whether you're scared that you'll lose your money or just don't know where to begin investing, it's common to hold large cash balances in deposit accounts, especially in times of market uncertainty. For example, in February 2013, Americans had $902 billion in checking accounts. Of course, it's wise to keep a certain amount of cash on hand in any financial plan, but keeping too much in deposit accounts has several drawbacks.
Low Interest Rates
Holding high cash balances usually means you're missing out on bigger returns elsewhere. Cash accounts, such as checking and savings accounts, are safe because they're covered by deposit insurance -- up to the $250,000 per financial institution -- and you won't lose money using them. But banks don't pay very high interest rates. If you're willing to take some risk, you can often achieve higher returns elsewhere.
When you hold cash, not only do you usually get a lower return, but your purchasing power decreases year after year if inflation outpaces the interest you receive. You might think that the 1 percent you're earning on your savings account is a safe rate of return, but if inflation is 2 percent, you're losing purchasing power. For example, say a quart of milk costs $1. At a 1 percent interest rate, after one year, every $1 in your savings account will have grown to $1.01. But, that quart of milk that you could have bought at the start of the year is now $1.02.
If you're hoarding all your cash at one bank, you could run up against the insurance limits on your deposits. As of 2013, the Federal Deposit Insurance Corporation and the National Credit Union Administration only cover the first $250,000 per person, per institution. So, if you're stashing away $300,000 and the bank goes belly up, you're only guaranteed to get back $250,000. If you're going to hold such a large amount in deposit accounts, consider spreading it among multiple institutions so that each one is under the limit and you're fully covered.
How High Is Too High?
Although there are several disadvantages to having a large amount of money in cash, you should keep an emergency fund of easily accessible funds. According to Suze Orman, you should keep an emergency fund equal to eight months' worth of expenses in an insured account, like a savings account or money market account, at a bank or credit union. Making sure the money is safe and accessible trumps taking risks to get a higher return. The size of your emergency fund varies depending on your expenses, so make sure you're counting everything you need to live, from your mortgage to your car payments to pet food.
- Bankrate.com: $12K in Checking? You’re Lemon-ing
- CNN Money: Suze Orman's Easy Money To-Do List
- Bankrate.com: How Big Should Your Emergency Fund Be?
- The Telegraph: Inflation Hammers Savers' Cash
- National Credit Union Administration: Frequently Asked Questions
- Federal Deposit Insurance Corporation: Insured or Uninsured?
Based in the Kansas City area, Mike specializes in personal finance and business topics. He has been writing since 2009 and has been published by "Quicken," "TurboTax," and "The Motley Fool."