While saving is an excellent habit, saving too much can lead to a situation where your hard-earned money is not utilized optimally, meaning that your savings do not grow in value or earn more for you.
What are the disadvantages of saving too much?
- Risk of loss due to fraud
With the increase in digitization, the likelihood of funds being stolen from your account is also on the rise. Keeping all your savings in your account makes you more prone to losing all your money in this way. It is best to park a sizable portion of your savings elsewhere as a measure of protecting it.
- Loss of investment opportunity
The standard of living is increasing and the value of money is decreasing. In these times, earning even a small amount of money by way of passive income can increase your net worth and purchasing power. You can do this by investing in a suitable avenue instead of keeping your money in your savings account.
What is the optimum amount to keep in your savings account?
If you keep too little an amount in your savings account, you may not have enough to meet your operational expenses. The disadvantages of keeping too much are discussed above. You need to find the optimum amount of cash to keep in your savings account. Determining this depends upon factors such as:
- Income-expense gap (the difference between your monthly inflows and outflows)
- Financial commitments (EMI on loans, SIPs)
- Stability of income (does it vary by more than 10% each month?)
- Lifestyle, responsibilities, and variability
The thumb rule is to keep an amount in your savings account equal to one to three cycles of receiving inflows. A cycle is the period between one major receipt and another. For salaried employees, it is one month. The amount to be retained per cycle is the aggregate of all budgeted payments. If the variance in income or expenses is high, this amount for three or more months should be retained in the savings account. If the income-expense gap is high and both are quite stable, an amount equal to one months’ total outflows is sufficient.
You must have a minimum threshold for your savings account. This is to ensure that you have sufficient funds to face any situation.
The minimum balance is made of three components:
- Expenses for 1 to 3 cycles, as explained above
- Money for emergencies, to be decided based on your life situation and priorities
- A buffer of at least 10% to 20%, based on your affordability
Securing your additional funds
Here are two popular ways in which you can use your excess funds once you decide on your minimum balance:
- Life Insurance Policy: A life cover gives you a lump sum at the end of a term or supports your dependents in the event of your death. This is a protective scheme, which is necessary especially if you are the sole breadwinner of your family.
- Mutual Funds: Mutual funds are combinations of stocks. There are various types to choose from and they mitigate the risk that stocks have through diversification. Mutual funds are also fairly liquid, depending on the scheme, in case you need money immediately.
To sum up
Keeping all your eggs in one basket is unsafe and the same goes for keeping all your savings in your bank account. It is advisable to invest in different instruments and grow the value of your savings.