Ask the expert: What is the role of savings accounts in a long-term investment program?
March 15, 2011
Q: I'm not sure what role a savings account should play in my financial set-up. I'm in my 20s, so I'm a long-term saver. I use my 401k plan at work, and also have an IRA, both of which I direct towards long-term investments. I have a checking account to take care of my immediate needs, and beyond that, I try to put every penny into my long-term accounts. So, is there really a role for a savings account in my situation?
A: Even with a young saver committed to making long-term investments in a 401k and IRA--which is appropriate and commendable--there is a place for saving accounts in the mix.
Someone who is saving for the long-term should be focused primarily on long-term investments. Vehicles like 401k plans and IRAs allow you to defer taxes on those investments, which may allow you to keep more of what you make in the long run. However, the price you pay for this preferential tax treatment is a restriction against accessing this kind of account until you approach retirement age. If you withdraw from these accounts before you reach the age of 59 1/2, you will pay a 10 percent penalty on top of any applicable state, local, and federal taxes.
In addition, tapping into a portfolio of long-term investments unexpectedly can be disruptive and costly. It could force the sale of a security at a bad time, and a sizeable withdrawal could force the rebalancing of the portfolio, resulting in extra transaction costs.
Therefore, the role of savings accounts or money market accounts in a long-term savings program is to act as a buffer, or an emergency fund. Its money you've segregated out from your checking account because it is not for routine spending, but it is accessible if absolutely needed, without disrupting your long-term investment plans.
Got a financial question about saving, investing, or banking? MoneyRates.com invites you to submit your questions to our "Ask the Recruiter" feature. Just go to the MoneyRates.com home page and look for the "Ask the Expert" box on the lower left.