Personal Finance

How Much Money Should I Keep in Savings?

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First, a hearty congratulations to you.

If you’re looking to build your savings, you’re already ahead of 44% of Americans who don’t even have enough savings to cover $1,000.

However, while storing money away for savings is generally a good idea, it’s still a balancing act.

Putting too much money toward savings could put you at risk for cash drag. Due to inflation, the purchasing power of your savings will diminish over time. The $10,000 you save today won’t be the same $10,000 ten years from now.

However, putting too much of your money into stocks and similar investments could expose you to market fluctuations. It’ll also limit your liquidity, which determines how much cash you have to seize once-in-a-lifetime opportunities.

So how do you determine how much money to put toward savings?

As with most important things, it depends.

In this article, we’ll review an easy framework for deciding how much money you should keep in your savings account, regardless of your current income or financial circumstances.

Emergency funds are useful because they provide peace of mind.

Emergency Fund or Dry Powder?

The amount of money you decide to put into savings will depend on the type of savings account. Generally, savvy investors hold at least two types of savings: an emergency fund and dry powder.

Emergency Fund

An emergency fund is just that: a savings account that is dedicated to emergencies. These include a job loss, medical urgency, or unexpected car troubles.

Emergency funds are useful because they provide peace of mind.

For instance, consider Sarah and Joel, two (hypothetical) recently laid-off employees. Sarah has $30,000 in savings, while Joel has $2,000. Despite both facing job loss, their responses differ.

Joel scrambles for any job to replace his income, whereas Sarah carefully seeks the right job. She feels secure with enough savings to weather the storm. Similarly, a substantial emergency fund provides reassurance and financial stability during crises.

In addition to providing peace of mind, emergency funds are also useful because they prevent terrible decisions.

With an emergency fund, you will be far less likely to take on bad debt. If mishandled, bad debt – like high-interest credit cards – will negatively impact your wealth.

An emergency fund typically takes the form of a savings account. It may also be worth checking out high yield savings accounts to grow your wealth with interest when you don’t need it.

Dry Powder

A dry powder fund is a savings account that is dedicated to seizing new opportunities.

The term is borrowed from the 17th century, when military battles were won with cannons and muskets. If a militia’s gunpowder was found to be moist, their entire artillery would be useless. With this in mind, military units kept large reserves of dry powder on hand to stay prepared for battle.

Likewise, you will also need dry powder to seize an opportunity.

For instance, let's consider Mateo and Grace, two young professionals aiming to grow their assets during the 2009 recession. Mateo has $50,000 in cash while Grace has $1,000.

A mutual friend proposes they invest in Netflix, and they both agree. Grace invests 5% of her savings, buying nine shares for a total of $50. Mateo also invests 5%, purchasing 484 shares for $2,500.

Nine years later, Netflix's stock price jumps to $360.57. Mateo's $2,500 turns into $174,515.88, whereas Grace's $50 becomes $3,245.13.

While Grace benefited from Netflix's success with a 6390.26% increase in her stock value, Mateo's larger initial investment led to significantly higher returns.

By dedicating a portion of your savings to dry powder, you will be in a much better position to seize once-in-a-lifetime opportunities.

By dedicating a portion of your savings to dry powder, you will be in a much better position to seize once-in-a-lifetime opportunities.

Keep Your Accounts Separate

Regardless of which type of savings you allocate money to, it’s important to keep your accounts separate. Your day-to-day checking account should remain independent of your savings, but your various savings accounts should also remain independent of each other.

Separating your checking from your savings will prevent any temptation to spend your hard-earned nest egg. Likewise, you don’t want to accidentally spend your emergency fund in a risky stock market.

Minimize confusion and risk by keeping all your accounts separate.

Allocating Money to Your Emergency Fund

You should have at least six months’ to a year’s worth of expenses in your emergency fund. If you are self-employed or work in a cyclical industry – like the construction and airline industries – consider saving up to double this amount.

Also keep your savings in an actual savings account. For example, a 401K isn't suitable for emergencies. Early withdrawal triggers penalties and taxes. Keep emergency funds in an easily accessible savings account.

When choosing where to store your emergency fund, consider using an online bank. Because these banks have lower overhead costs than traditional brick-and-mortar banks, they generally provide higher interest yields to their customers. This means more money for you in the long run. If the online bank is FDIC insured, each account will be protected for up to $250,000 per depositor.

Once you reach your target savings goal, add extra cash each year. This way, you’ll prevent inflation from eroding your emergency fund’s value.

Allocating Money to Dry Powder

Unfortunately, there isn’t a one-size-fits-all approach to determining how much money you should allocate to dry powder. This ultimately depends on your own financial goals.

Unlike your emergency fund, however, feel free to keep your dry powder in cash equivalents, like money market accounts, money market funds, or short-term CDs. This way, you can enjoy high liquidity while also capitalizing on market returns.

Don’t Forget to Invest the Excess

While it’s important to keep a substantial amount of savings for emergencies and opportunities, don’t forget your long-term financial goals.

Savings provide risk-free liquidity, but without risk, you’ll miss the opportunity to gain large financial returns. Determine how much risk you can tolerate, then invest the remainder so your wealth can multiply.

Build Your Wealth with Axos Bank

Ready to start building your savings? Axos Bank is here to help.

As a digital bank, our operation costs are lower than traditional banks. This means better interest yields for you and more money for your savings account. Our High Yield Savings and High Yield Money Market accounts earn higher interest than the average traditional bank (compare our rates to the national average).

Don’t waste your hard-earned savings on paying for your bank’s electricity bills. Get started with our revolutionary savings accounts today.

How Much Money Should I Keep in Savings?

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