A majority of Americans reported cutting back on their spending in 2009. Fifty-six percent said they were eating in restaurants less often, 59% were spending less on vacations, and 36% postponed an auto purchase. In all, 76% said they had cut back in at least one area.
So it’s not surprising that the personal saving rate has been running higher than normal. It even hit 6% in May 2009, the highest point during this century.
Spending less and saving more is always a good idea, but what should you do with the money you save? Here are some common mistakes to avoid if you have been stockpiling your cash.
Locking It in Too Long
Certificates of deposit are a popular place to park money for the short term, but locking in your cash for years when rates are low means you may not be able to change course if conditions improve. Although inflation has been fairly low, many economists believe it could make a resurgence in the next few years. Inflation is bad news for consumers but good news for fixed-income investors because they can benefit when interest rates rise. If you want to put your cash in CDs, consider those with shorter maturities; they pay lower interest rates but don’t carry a high opportunity cost. FDIC-insured CDs generally provide a fixed rate of return.
Not Paying Off Debt
If you have significant personal debt, it’s usually a good idea to pay it down before you start building a cash reserve. Although you probably shouldn’t send every last penny to your creditors, keep in mind that interest expenses actually slow your ability to save money. The sooner you pay off your debts, the more you can devote to building the cash in your portfolio.
Playing It Too Safe
FDIC-insured savings accounts offer a safer way to preserve your principal, usually in exchange for a low return. In fact, the long-term effects of taxes and inflation could actually reduce your money’s spending power over the long term. A little money in the bank is essential, but it may be a good idea to put larger sums to work.
It may be comforting to have a cash position, but keeping too much in cash alternatives could result in a lower-than-expected nest egg. If you’ve got some cash on the sidelines, consider whether it’s working hard enough to help you pursue your future goals.