Saving money is one of the most basic principles of personal
finance, but often it can be one of the most challenging. Not only do you have
to take action to save continually, but you also need to think wisely about where
to keep that money.
And while it may have once been easy to stick your money in
a savings account, let it accrue interest and forget about it, that interest is
now more elusive. The low interest rates for savings accounts and certificates
of deposit we’re seeing today won’t last forever, but they do provide a reality
check for aspirational savers.
Twenty years ago, it was possible to get a CD that yielded
4% to 6%. But since the Great Recession, even the best CD rates have stayed
pretty low, drifting below 1% in 2020.
The same goes for high-yield savings accounts, often
promoted by online banks that can extend higher interest rates in part due to
their lower overhead. But while it was possible to snag an APY of around 2% in
early 2019, those rates have dropped dramatically over the last year, and even
further with the onset of the coronavirus pandemic.
Right now, you’re lucky to get half a percent to 1% APY on
your “high-yield” savings, though that’s still much better than the average APY
for a standard savings account at a bank: about 0.05%.
And those rates aren’t going to increase any time soon. The
Federal Reserve has said it will keep interest rates low for several years, to
allow the unemployment rate to recover and inflation to increase slightly.
Interest rates are low because economic growth is low,
explains Tim Chubb, senior vice president and CIO of Girard Advisory Services.
The Federal Reserve is trying to kickstart growth by encouraging people to take
on risk instead of keeping their money in more comfortable spots, like savings
accounts. But as already-low rates continue to drop for those products, it
disincentivizes people who have previously gotten larger returns saving through
these methods, he says.
How to Adjust Your Saving Mindset
Low interest rates didn’t appear overnight. We were already
facing low interest rates before the coronavirus pandemic, Chubb says, because
while the economy was growing, it was growing at a slower rate than it had been
in the years prior.
Then, the coronavirus sent the economy into a tailspin,
which means it’ll take some time to get back to that gradual growth we saw
previously. “Don’t expect rates to normalize with 3 and 4% APYs for CDs,” Chubb
says. Instead, you’re better off thinking about what to do with your money
right now, rather than hold out for the unknown future of interest rates.
Steve Pilloff, associate professor of finance at George
Mason University’s School of Business,
warns that thinking of today’s interest rates as “bad” will do you no favors
in your attempts to save. Thinking, “Interest rates used to be better, but now
they’re bad,” Pilloff says, reminds you of how little you’re earning.
“It is what it is right now” is a better way to consider
interest rates, he says. And remember that “it is what it is” for everyone at
the same time. “Nobody’s earning it,” Pilloff says, thinking back to those
coveted higher-rate environments. “The only way is to take on a lot of risk.”
Just Starting to Save? Focus on Your Progress
Before we get to that risk, let’s go back to the basics of
saving money.
Don’t worry about chasing the best interest rates that
high-yield savings accounts and CDs offer, Pilloff says, since those rates may
only differ by a fraction. “Where you put your money away is less important in
low-interest environments,” he says, noting the bigger issue is putting your
money away at all.
If you’re just starting to save an emergency fund or for a
major purchase, focus on fostering that savings habit, rather than worrying
about the interest you’re earning (or not earning). You can always move your
money to a new or different account once you start building momentum.
“It’s not a major mistake if you leave your money in
checking,” Pilloff says. “You’re not losing out on that much money to be made.”
Instead, focus on your own planning and determination. “The
magic of compounding interest is a lot less magical,” in a long-term, low-rate
environment, Pilloff says. “To get where you want to be, you need more
discipline.” But with discipline, he says, you can be even prouder of the
savings you can accumulate on your own.
Think Beyond Cash Savings
What about those who have already saved a pretty penny and
want to strategize for growth?
Chubb says you don’t have to keep cash in a savings account
or CD just because it’s what you’ve always done. “Individual investors and
savers need to think about how much they want to hoard in cash,” he says.
While it’s recommended to have at least three to six months
of cash for expenses on hand in case of a financial emergency, it doesn’t make
a lot of sense to hold onto much more than that in a low-interest environment,
Chubb says.
This doesn’t mean you need to completely switch gears and
put all your cash into your 401(k) or IRA to use decades from now. You may want
to consider opening a taxable investment account if you’re comfortable taking
on more risk in the hope of a greater return.
A taxable account allows you to withdraw funds at any time,
and you only pay taxes on your capital gains—your money’s growth—which is
cheaper than having to take money out of a retirement account early. It’s a
good option if you’re just starting to focus on saving for a long-term
financial goal, like buying a home, sending kids to college or another “rainy
day,” Chubb says.
But it’s not a fit for everyone. Chubb says to make sure you
have savings buckets well established for emergency expenses and max out your
retirement contributions before investing in a taxable account.
While taking on risk by investing your savings in the market
could bring in returns, there’s also the risk that you’ll lose money along the
way. And if you’re saving for a specific rainy day or special project you’ve
been planning for a while, you’d probably hate to see any of your hard-earned
savings slip away.
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