Over the past year, many Americans have amassed money to prepare for the uncertainty of the COVID-19 pandemic. So much so that the personal savings rate of Americans has reached record levels. The U.S. Bureau of Economic Analysis (BEA) reported that Americans’ savings rate reached 33% in April 2020, the highest ever recorded by the BEA.
As 2021 approaches, Americans’ savings rate has declined as the economy reopens, with consumers releasing pent-up demand. However, even with higher spending compared to 2020, Americans continue to show high savings rates compared to pre-pandemic levels.
While it may seem prudent to maintain excess levels of money in a savings account, there are also opportunity costs to consider in keeping extra cash on hand. Most importantly, it is worth considering the return that can be generated in a savings account. The rate of return on a savings account (even a high yield savings account) continues to be below the historical average and is unlikely to keep pace with inflation. These extra reserves fail to even cope with their purchasing power and end up losing value in the long run. Instead of leaving funds on the sidelines underutilized, there may be more practical solutions for that money to maximize overall return.
Maximize 401 (k) and IRA contributions
First and foremost, maximize the contributions to your pension plan offered by your employer. While you can’t fund a 401 (k) from your savings account, it may be a good idea to get less take-home pay by increasing the amount deducted from your paycheck. Money taken from take home pay and placed in a 401 (k) reduces taxable income. If you do not participate in a 401 (k) or other qualifying plan, contributions to a traditional IRA may also be tax deductible.
Contribute to the Health Savings Account (HSA)
Another investment vehicle that could potentially be a home for additional funds is a Health Savings Account (HSA). HSAs allow an individual to contribute annually towards health care costs and offer significant tax benefits. Some of the benefits of an HSA are:
• Contributions to an HSA are tax deductible at the federal level, which reduces your taxable income.
• Contributions and income increase sheltered from federal tax
• Withdrawals for eligible reimbursable medical expenses are also tax-exempt – whenever they are taken, regardless of age.
Pay off the debt
Apart from investing excess cash, paying off outstanding debt is another way to reduce the opportunity cost of excess cash. Making prepayments on bonds, like credit card payments and car loans, could be an effective way to save interest and fees. Paying off debt sooner than expected basically allows someone to create a rate of return. To illustrate this, if there is an annual interest rate of 5% on a loan and we manage to repay this loan 12 months before maturity, this individual has just blocked a 5% return on his loan. silver.
Review existing plans
You may also want to take this time to review your risk management plan, including items like auto insurance, life insurance, and disability insurance. If you need more coverage, you can use your extra funds to set up the coverage you need.
If you feel like you are in a position where you don’t know how to maximize your additional savings, you should take the time to think carefully about your larger goals and how you can use the money to achieve them. Investing your money in the stock market can help you reach your long-term goals faster. Although this carries more risk than keeping money in a savings or money market account. It may be beneficial to partner with a financial advisor to analyze your goals and design a portfolio that you are comfortable with navigating this market environment.
Balaj Singh is a research analyst on the West Capital Management research team and supports the West Capital Management investment committee. Singh is responsible for investment due diligence on managers and strategies, portfolio construction and performance reporting. Singh graduated from Rutgers University with a Bachelor of Science in Finance and Accounting with a minor in Economics. Singh has achieved the CAIA® designation and is currently a Level III candidate in the CFA® program.