With interest rates at historic lows, savings accounts just aren’t paying the kind of interest they used to. Many big banks are paying between 0.01% and 0.10%, which is essentially nothing. Online bank interest rates are currently ranging from about 0.5% to 1%, which is certainly more but still nothing to get too excited about. In both cases, your money is losing some purchasing power due to inflation.
With rates so low, many people are wondering what they should do with their short-term savings. If they’re currently with a big bank, should they move to an online bank for a better rate? If they’re currently earning 0.8%, should they switch to an account that earns 1%? What about putting some money into slightly riskier investments, such as bonds or even stocks, in the hopes of a higher return?
My advice? For short-term savings, the interest rate should be one of your last concerns. It’s much more important to focus on your contribution rate and the convenience of the account for your savings purposes. Let me talk about some of these factors one at a time.
What are short-term savings?
First, what do I mean by short-term savings? Any money that you might need in the next 1-2 years should be considered short-term. This would include your emergency fund. It includes any “saving to spend” funds. It should also include any other savings goal where you can’t afford for the actual dollar amount of the account to drop.
Where to keep this money
There are three main factors to consider when choosing a bank for your savings:
1. How easy it is to transfer money into the account?
2. How easy is it to access the money in a relatively short time period without penalty?
3. Are there any restrictions, minimums or limitations on the account that will cause problems?
The first factor is pretty simple. It should be very convenient for you to send money to this account, preferably with automated monthly transfers from your checking account. Most banks will allow you to do this, but make sure that you understand the process and that it will be easy for you.
You should also be able to access the money relatively easily, though you might want to consider using an account where the access isn’t too easy. For example, withdrawals from most online savings banks will take about 3 business days to reach your checking account. This is quick enough that it gives you good access, but not so fast that you’re tempted to use your savings for impulse spending. In any case, you should make sure that there aren’t penalties assessed for regular transactions. Penalties can often wipe out any interest the account has earned.
Finally, understand any other restrictions, minimum account balances and other limitations that might be on the account. If any of these seem like they will cause a problem, look at other bank. There are enough options that you should be able to find one you’re comfortable with.
Does it fit your savings strategy?
You want to choose a bank that will allow you to save in a manner that fits your overall strategy. For me, I like being able to segregate my savings my goal. Some people can manage this with a single account and simply track their savings goals in excel. I prefer to have this accomplished with either different accounts, or with a single account where the bank lets you segregate different purposes. One of the reasons we chose Ally Bank for our short-term savings is that it’s really simple to add multiple savings accounts, name them for our different goals, but essentially manage them as one account. I’ve also heard from a lot of people who use ING for this same purpose.
This particular purpose may not be an important factor for you. But the point is that you should know how you want to use your account and make sure that the bank you choose will allow it.
How to grow these accounts
The biggest factor in growing the balances on these accounts is not the interest rate. It’s your contribution rate. Remember, these are short-term savings, so no matter what rate you’re earning they won’t have a lot of time to compound and grow. It’s much more important to focus on how much and how often you are contributing. If you can contribute $100 per month, you’ll have added $1,200 in value over a year. In that same period, you would earn about $6 in interest with a 0.1% rate and about $68 in interest with a 1% rate. There is definitely a difference in interest there, but it pales in comparison to what you can add just by contributing more. A focus first and foremost on your contribution rate will go much further towards building your savings.
With that said, it does make sense to focus on interest rates to some extent. If you find several options that fit all of the previously mentioned factors, then choosing one with a more competitive rate makes some sense. I would look for a bank that has consistently offered a competitive rate. It’s less important that it’s the best right now than that you can feel confident that it will be near the best going forward. It’s consistent good service that you’re looking for, not a short-term highest offer.
Be in it for the long term
Whatever option you choose, you should feel comfortable with that being your banking option for the long-term. It doesn’t mean that you’re committing forever, or that you couldn’t change your mind, but you should go into it with the realistic hope that it’s a relationship you can keep. You don’t want to get into the interest-rate chasing game, and you don’t want to have to re-do all this work in another 6-12 months. Finding a bank that you feel like you can work with for years will allow you to set up your system and move on with as little further stress as possible.