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The Motley Fool has been helping ordinary people become better investors for nearly two decades. This month, we're reaching out to millions of investors to help guide them in their quest toward financial knowledge and independence.
Along those lines, I'm exploring a range of different areas of the investing world. As popular as stocks are, they're definitely not a place to stash all your spare cash. Whether it's for an emergency fund for rainy-day expenses or for future investing once a stock you like falls to a more affordable price, cash plays a vital role in your portfolio, and what you do with it can make a big difference in your overall income. Today, let's look at why holding cash is so hard today and what you can do to put the odds in your favor.
Helicopter Ben and your savings account
For nearly four years now, the Federal Reserve has held short-term interest rates to a range of between 0% and 0.25%, essentially as low as they can practically go. Historically, the Fed has often used its interest rate policy to nudge economic growth in one direction or the other, pushing rates higher to discourage investment in growth-creating opportunities and pushing them lower when it wanted to encourage greater economic activity.
Interest rate movements always represent a trade-off. Savers obviously prefer high interest rates so that they can get more interest income. If you're a borrower, then you prefer lower rates, because they cut the amount of interest expense you have to pay on your loans.
For millions of savers, low interest rates have created an income crisis. Once-dependable interest rates in the 3% to 5% range have disappeared, and many banks pay next to nothing on their FDIC-insured savings accounts and certificates of deposit.
Banks have cut back savings rates to the bone for a pretty obvious reason: Every dollar they pay in interest is one less dollar of profit. Big national banks Wells Fargo (NYSE: WFC ) , Bank of America (NYSE: BAC ) , and JPMorgan Chase (NYSE: JPM ) have all had to pay billions of dollars to settle charges of foreclosure abuse from federal and state regulators, giving those banks incentives to pick up the slack elsewhere. Limitations on ancillary fees such as credit-card-related swipe fees have cut the amount that issuing banks get from credit card networks Visa (NYSE: V ) and MasterCard (NYSE: MA ) , in turn making issuers' credit card businesses less profitable. In order to make up for those hits to their bottom lines, banks are doing what they can to limit their costs of capital.
How you can fight back
You may feel powerless against the combined might of big financial institutions. But in reality, you have more leverage than you may think. Thanks to ongoing competition from upstart banks, you can often find much better rates than you'll get at the biggest banks.
One of the most popular places to look for relatively high rates on savings accounts and CDs is the online banking industry. Without networks of expensive branches to maintain, online banks can afford to pay more of their income back to savers in interest.
Don't expect too much, though. Even with the best online banks today, it's hard to get much over 1% on your money. At just over $8 of interest monthly on a $10,000 investment, you won't feel like you've won the lottery when you find a 1% rate. Still, if you have larger amounts of cash on the sidelines, even 1% can represent a much-needed boost for your income.
Save what you need
Even at the best rates available, holding cash is costing you in terms of purchasing power after taking inflation and taxes into account. Unless you have substantial cash needs in the immediate future, having a big cash balance right now is costly. But for the cash you do need to have on hand, managing it well can get you at least a bit of valuable extra income for your trouble.
For some useful help in finding the best rates available, Bankrate has a wide range of different tools and searches you can use. Also, check out the Fool's 60-Second Guide to Short-Term Savings to make sure you're on top of your financial situation.
Please stay tuned throughout the month for other informative articles covering a wide range of important topics. Let me also encourage you to take a look at the special website we've set up at InvestBetterDay.com. On Sept. 25, we're taking a day to celebrate the art of investing, and we encourage your participation. Take a look at the site now and get on the path to personal prosperity.
Bank of America profits when it pays low rates to savers, but is it a smart stock to buy? Find out in the Fool's premium report on Bank of America.