You're being financially responsible. You're socking long-term money away in stocks, through tax-advantaged retirement accounts such as IRAs and 401(k)s. And you're keeping a bundle -- three to nine months' worth of living expenses -- in cash or similarly safe and accessible financial instruments. You're actually hurting your long-term wealth, though, because the average savings account is paying about 0.09% in interest. Yikes!
Just the facts ...
Let's put that national average interest rate for savings and money-market accounts (per the folks at Bankrate.com) into perspective. Let's say you have a whopping $25,000 parked in short-term savings as your emergency fund. It's there to save you, should you unexpectedly lose a job or face a financial crisis. Since you've chosen not to bury the money in your backyard or stuff it into a coffee can in the back of your freezer, you're hoping that it will keep its value and, ideally, grow over time. Well, sorry. Over one year, a $25,000 investment will earn, at 0.09%, the princely sum of ... $22.50. Yup, barely enough to pay for a dinner.
If you could even manage to quadruple that figure, to earn 0.36%, you'd still collect less than $100 on a sizable account balance. It's worse than that, though, because that money is meant to stay in short-term investments for the long term, and with rates so low, you will actually lose purchasing power over time, because of inflation. Historically, inflation rates have varied widely, but they have averaged about 3% per year. Thus, to preserve your purchasing power, you want to earn at least that much. And to grow your wealth, you'll want to earn more than that.
These days, with interest rates so low, it's hard to beat inflation in low-risk investments. Low rates won't last forever, though, and rates are expected to start inching up in the coming year or so. Still, why collect an interest rate such as 0.09% when you can do better than that?
Start at Bankrate.com, where you can check out national and local average rates and can also see the best rates that it's found around the country. Remember that you don't have to do your banking or investing in your own neighborhood. You can open accounts at far-flung financial-services companies -- and some are targeting a national customer base to begin with.
Internet-based banks offer a case in point. Ally Bank, a unit of Ally Financial, is a specialist in automotive financing and is also a major online bank with more than 775,000 customers. It has recently been offering an interest rate of 0.99% for its savings accounts. That's more than 10 times the national average and will net you $250 instead of $22.50 on a $25,000 balance. Synchrony Bank, a unit of Synchrony Financial, recently spun off from General Electric, is offering 1.00% on savings accounts. These are not the only options for (relatively) high-yielding savings accounts, and these and others offer strong money-market account rates, too.
You might use certificates of deposit, or CDs, for your emergency fund or other short-term savings needs, too. The national average rate for one-year CDs was 0.27% recently, per Bankrate, but the site also listed available rates ranging up to 1.31%. You can get even higher rates for longer-term CDs, such as 1.5% for a three-year CD and 2.25% for a five-year one. You don't want to lock in most of your money for five years, but if you're saving a chunk of money for college expenses that are five years away and you don't want to risk a badly timed stock-market crash, a CD is worth considering.
You might ladder some CDs, too, by splitting up your investment among a one-year CD, a two-year CD, a three-year CD, and perhaps a four-year and five-year one, too. Then, as each matures, you can roll over unneeded funds into a new CD at a rate that is, one hopes, higher. You need to be paying attention to your finances to make this work, but you might also find that your bank can automatically roll over maturing CDs into new ones.
If you have a brokerage, you might look into "brokered" CDs, which often offer higher interest rates and can also not lock you into various time frames. They can be traded on the open market, letting you in and out of CDs relatively easily (though with a commission charge).
Finally, consider bonds. You might, for example, invest in "I-bonds," which try to keep up with inflation. You can buy them online at TreasuryDirect.com, though no more than $10,000 worth per year. They will never go down in value, though their interest rate can drop. It's hoped that you'll hang on to them for at least five years, so you'll forfeit some interest if you can them in before that. But if rates rise, you can cash them in and buy new ones at the higher rates. The latest 30-year fixed-rate is 1.48% and it's adjusted twice per year.
So don't settle for an ultra-low interest rate when you can enjoy an above-average low rate. Small interest-rate differences can make a big difference in your long-run financial health.