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Savings Interest Rates Suck, But Here’s What You Can Do About It

Today, I want to tackle a common question: When savings account interest rates suck, how else can you get a return on your cash?

Here’s how one reader phrased it:

I’m a single young professional without any debt. I make a decent living. I have a 401(k), Roth IRA, and an emergency fund. Currently my expenses are the usual rent, food, car insurance, etc. The money I am saving is currently just sitting and stacking up in my savings account earning a minimal interest rate. I want a better return. What should my next investment move be? Stocks? Bonds? Nothing? And how much risk is involved? My next goal would be to buy a house within five years.

When I started this blog in 2006, the economy—and interest rates—were in an entirely different place. Many high yield savings accounts were paying rates of over 5.0%. Today, those same banks are paying less than 1.50%. Rates like those barely reward you for saving at all. But that’s not a conincidence: The government wants us to spend—not save—to stimulate the economy.

But twentysomethings are not the rest of the country.

We’re in a unique place in life. We’re trying to start emergency funds and save for first homes and retirement. Perhaps we’re paying off student debt. And we’re doing it all on entry-level salaries.

Regardless of what the economy’s doing, we twentysomethings still need to save a bit. And that’s hard to do when interest rates are so crappy.

Here’s a solution:

1. Relent

Your emergency savings don’t need to—and probably never will—earn much of a return.

Accept it. Your emergency fund of between six and nine months’ living expenses is for emergencies. It needs to be liquid so you can accessible in a true emergency. (For example, a natural disaster that destroys your home). That means it needs to be cash in a savings or money market account.

For most, that means online high yield savings accounts will have to do. The rates aren’t great, but they’re better than most can do at a local institution. Plus, your money is just an electronic transfer or an ATM withdrawal away.

2. Focus on Debt…

Before you worry about earning interest, stop paying it.

Even if you are in debt, I do recommend setting aside between two and four weeks of expenses in an emergency fund. If something happens and you haven’t saved anything, you’ll just have to turn to credit cards again anyway. But if you’re in credit card debt, only save for two to four weeks. Then focus on getting rid of the debt!

When you pay down a credit card balance at 12, 15, or 20 percent interest, it’s like getting a guaranteed return on your money. You just can’t beat it.

3. …Then On Retirement

Stop ignoring this one and save for retirement already.

If you have a 401(k) plan at work, contribute 10%. If you don’t, or you want to save more, open a Roth IRA and contribute up to the annual maximum of $5,000. Invest in target-date mutual funds or simple index ETFs.

4. Finally, Stop Saving; Start Investing

To make real money, you’ll have to take some risks.

The trouble with online savings accounts and their low APYs arises when we reach a certain place in life:

  • We’re happy with our emergency fund.
  • We have no credit card debt.
  • We’re funding our retirement accounts.

If we’re managing our money well, we have cash left over that we want to save for other life goals like buying a home, a car, or quitting our job to travel the world.

When you’re here, you don’t just want to save, you want to invest. Carefully.

Although young investors can take big risks with our retirement portfolios (and, subsequently, hope for bigger gains), we should be more cautious with money we want to use in the next five or ten years.

Explore the Market

So this is where it pays to learn a thing or two about investing and how to create a well-balanced portfolio. You can still stick with mutual funds and index funds, but you shouldn’t put all of your money into stocks…personally I would consider some bonds and cash, too. To start, I recommend reading any of our investing posts by our resident guru Mark Riddix. The guy knows his stuff.

Then, it’s easy to get started trading with any number of discount online stock brokers.

Try Social Lending

For more adventurous investors, there’s also Lending Club, a peer-to-peer loan network in which you lend money to others at rates of between seven and 20 percent. So far, returns average 10-12 percent. Any investment is risky, and Lending Club is no exception (your borrowers can default).

I’ve put a little bit of money into Lending Club this year and am earning about a 11% annualized return. If that keeps up, you can bet I’ll continue to make Lending Club a bigger part of my financial strategy. Read more about whether Lending Club is a smart investment.

Regardless of whether you choose the stock market, peer-to-peer lending, or another strategy, if you invest wisely, you should be able to get gains of at least between four and six percent a year without worrying about losing a huge chunk of your capital at any one time. No bank account can do that.

The bottom line? If low savings rates have you down, reevaluate your finances to make sure the bank is really where your money should be sitting.

  • Need cash for emergencies? Forget about the rate.
  • Do you have debt? Pay it off.
  • Have you saved for retirement? Do it!
  • Otherwise, start investing…

What about you? Have you reached this stage in life and started to invest for the short-term as well as for retirement? How are you doing it?

About David Weliver

David Weliver is the founding editor of Money Under 30. He's a cited authority on personal finance and the unique money issues we face during our first two decades as adults. He lives in Maine with his wife and two children.

Comments

  1. Just curious: what do you think of people signing up for checking accounts that offer interest? My bank pays 3%, but it does have its limitations. I have to make a certain number of direct deposits and debit card purchases to earn interest. But, for me, it’s manageable.

    • David Weliver says:

      If you find an offer like this and can meet the monthly requirements (like you said, usually direct deposit, online statements, and some number of monthly debit card purchases), then definitely go for it as part of your overall strategy. I’ve seen one such checking account that offers 4.01% APY.

      That said, I’m not sure these accounts make sense as a primary vehicle for long-term savings. Many have maximum balances on which they will pay the attractive interest rate. And even if they didn’t, I personally don’t like the idea of keeping all my savings in a checking account—if a thief gets your checkbook, he could clean you out. Personally, I might keep $5-$10k in an account like this, but sacrifice the interest rate for security with the rest of my liquid savings.

  2. You mentioned using an online high yield saving account for your emergency savings. Do you really have to use online banking services for your emergency fund? Using your local bank, or one that is really close to your home might be a good choice because you won’t be making that much interest where ever you go and at least your money will be close to home in the case of an emergency.

  3. I am a late 20-something and have no short term or even mid-term debt. I make a good living, being blessed with probably the best employer I’ve ever had. I am an entrepreneur as well, but that isn’t something that’s developed. I save and invest in the markets, but personally, I see value in things that will pay me back when I’m ready to retire – like being a landlord. All of that rent being paid directly to me seems like a smart play. There’s costs involved, sure, but unless my properties fall into sinkholes or get eaten by hurricanes, the costs are less than 17% per year (includes my property management group).

  4. Looking for a place to park 500K but cant find anything paying more than 1.2%. Anything better out there. cj

  5. Loan network in which you lend money to others at rates of between seven and 20 percent. So far, returns average 10-12 percent. Any investment is risky, and Lending Club is no exception (your borrowers can default).
    _____________
    Edward

  6. Empty Pockets says:

    http://signon.org/sign/the-feds-zero-percent?source=c.em.cp&r_by=2648148

    Please sign “Raise the Savings Interest Rate!” Petition. Don’t let one more day go by without the bank paying you a fair interest rate on your savings while they use your hard earned savings! Ordinary folks don’t gamble in the stock market. . .don’t have funds transferred overseas. . .and we certainly don’t have financial portfolio managers. We have saved responsibly and we are asking for a Fair Savings Interest Rate on the money we worked so have to save. Add Your Name Today! We need Savers of All Ages to Sign so we can go forward with this petition. It will be delivered to Bernanke & the FOMC, and President Obama. Savers across the USA have signed and shared their stories of how Bernanke’s zero percent savings interest rate policy has ruined their lives. Fight back!