Make a Few Simple Changes and Earn More
By Monica Steinisch
The Federal Reserve has cut interest rates nine times this year (the last time was on October 2), and many of us are watching as the interest we receive on our passbook savings accounts dwindles to almost nothing. As of October 11, in fact, banks nationwide were paying an average interest rate of just 1.09 percent on passbook accounts—far below the inflation rate—and some banks have been paying less than that. Meanwhile, the cautious among us are keeping more of our money out of the stock market and putting it in interest-bearing investments, so collecting every penny of interest available to us is as important as it's ever been.
Even before interest rates plunged, American savers were missing out on some of their rightful interest income. Last year, the Consumer Federation of America (CFA), a Washington, D.C.—based nonprofit consumer advocacy organization, quantified our loss. It commissioned a study of Federal Reserve Board data on American saving habits that showed that, as a nation, we are leaving up to $50 billion in potential interest payments on the table every year. Why? Too often, we are depositing our money in low-yielding savings vehicles, such as passbook or statement savings accounts.
As surprising as it may be to learn that savers-including low- and moderate-income savers who can't afford to walk away from earnings—are missing out on such a huge amount of interest income, the findings of the study are actually quite encouraging. That's because they show that the most common barriers to saving money in higher-yielding accounts are easily overcome.
Obstacles to Higher Yields
Why are savers letting interest income slip through their fingers? In another survey, CFA uncovered some of the reasons. For one, millions of savers are badly informed about the features and yields of different savings options. They also lack awareness of the dramatically positive effect that even a single point increase in interest can have on their savings over time. Finally, they make their choices out of habit and not with an eye to getting the best returns.
In short, too many of us think that the interest we can earn on modest savings balances is not significant enough to warrant the time and energy we'd need to research alternatives and shift our money to new accounts. Clearly, many of us have not witnessed the magic of compound interest.
How Do You Rate?
According to the Consumer Federation of America, American savers are missing out on higher interest rates because of a few widely shared misconceptions. Do you share them? To find out, answer the following questions.
- 57% of savers do not know the interest rate being paid on their savings accounts, making it virtually impossible to recognize a higher-yielding product. Do you know the interest rate being paid on your accounts?
- 30% of savers think there is little difference in the interest rate paid on a passbook savings account vs. a certificate of deposit (CD). do you know the difference? (Correct answer: A typical CD can offer a rate as much as 2 to 3 percentage points higher.)
- 46% of savers said not wanting to "tie up their money" is a reason for not shifting funds from traditional savings accounts to CDs. Do you know what the minimum term is on a bank CD? (Correct answer: three months. Does that surprise you?)
- Many Americans are unaware that many higher-yielding savings alternatives are insured or guaranteed by the U.S. government. Did you know that CDs are insured?
- Many savers prefer to keep their money at a local bank or credit union-even at low interest rates-with 80 percent citing convenience as a basis for their choice and 59 percent saying that access to live tellers is crucial. Do you realize that you can increase your interest earnings simply by choosing a higher-yielding product offered by your local bank (CDs or bonds, for example) or by moving your money from a bank to a credit union?
How Much Are You Losing?
While a $50 billion national loss of interest sounds impressive, it may not be convincing to you if you don't think that a few more percentage points will brighten your financial future. To get a handle on what higher yields mean for you and your family, consider these very real numbers:
Value of monthly deposits of $100 at various interest rates, compounded monthly, over varying periods of time
The figures don't lie—interest rates matter. In fact, rate of return and length of time are the two critical factors in making your savings grow for future wealth. That means: Get an early start on saving and keep shopping around for the best returns.
Where to Find Higher Rates
Today, it's easier than ever to track down higher yields. The Internet lets you rate-shop right from your computer. And with phone, mail, and electronic funds transfer, there's no reason to be bound by geography when it comes to opening and maintaining an account. Although many Web sites offer rate information, www.bankrate.com is probably the single best source of information for the smart saver (or borrower; see "The Savvy Borrower" elsewhere in this issue of the newsletter). Every week it surveys nearly 4,800 financial institutions in 50 states to provide consumers with up-to-date rate information. Visitors can search by product, geographic area, or simply "highest yields." Please check it out for specific examples of the higher-yielding options below, and also look at "Certificates of Deposit/Money Market Funds" on page 7 of this issue of the newsletter.
Where then, will you find higher yields than you can get from the traditional savings accounts offered by your bank?
Money Market Accounts: MMAs offer rates that, while not the highest in the land, are often twice as high as those on savings accounts. Although there may be penalties for slipping below minimum balance requirements or for exceeding monthly withdrawal limits, there are no time restrictions: You can withdraw your money at any time, without penalty. Money market accounts usually offer check-writing privileges. As of October 12, the average rate on money market accounts nationwide was 2.47 percent.
Money Market Mutual Funds: Money market funds are low-risk mutual funds that usually offer a higher yield than savings account or money market accounts. What makes them low risk is that they invest in cash-like instruments such as Treasury notes and bonds. Although they're not insured or guaranteed, they're extremely safe. Drawbacks include having to make a higher initial deposit (this can sometimes be avoided by setting up a monthly direct deposit of $50 or $100). Before investing in a money market fund, you'll need to read the fund prospectus, which will give you information on fees, features, and requirements.
Certificates of Deposit: CDs can be purchased in a variety of maturities, generally from three months to five years, and, at many institutions, for as little as $250. They pay significantly more interest than traditional savings accounts and money market accounts. Average rates as of 10/12: 3-month CD: 2.52 percent; 1-year CD: 3.07 percent; 3-year CD: 3.83 percent.
U.S. Treasury Bills and Savings Bonds: The U.S. government provides a number of ways for you to improve your return without putting your savings at risk. Series EE or I Savings Bonds can be purchased in eight denominations (ranging from as low as $50 to as high as $10,000) from most banking institutions or (better yet) with no commissions or fees directly from the U.S. Treasury at http://www.publicdebt.treas.gov/. Though Savings Bonds have a very long maturity (up to 30 years), they can be redeemed anytime after the first six months with only a three-month interest penalty (there is no penalty after a bond is held five years). Series EE savings bond rates (currently 4.5%) are competitive with CDs and money market accounts (Series I bonds, which are adjusted for inflation, pay a higher rate, currently 5.92%). And there's another advantage: Interest earned on the bonds is not subject to state or local taxation, and federal taxes are deferred until the bonds are cashed. (For more on Savings Bonds, please see The Road to Wealth, pages 429-33, or the ASK SUZE book on Stocks and Bonds, pages 119-25.)
Treasury Bills, or T-Bills, are a short-term investment, available in maturities of 4 weeks (just introduced in July), 13 weeks, or 26 weeks. The minimum investment is $1,000. Like EE Savings Bonds, they are bought at less than face, or "par," value and mature at par. The difference between the purchase price and the face value is the interest you earn. While rate shoppers might find equivalent rates at some banks, banks can't offer the tax advantages of T-Bills, which are state and local income tax-free, just like Savings Bonds are; however, they report interest on an annual basis, so they are not federal income tax-deferred. (For more on Treasury Bills, please see The Road to Wealth, pages 428-29, or the ASK SUZE book on Stocks and Bonds, pages 105-107.). You can buy T-Bills from your bank or a broker or you can purchase 13-week and 26-week T-Bills at an auction conducted by the Department of the Treasury (Treasury Direct). (Four-week T-Bills are not available direct through auction.)
Savings Bonds (as of October 12)
EE Savings Bonds -- 4.5%
I Bonds -- 5.92%
(Interest rates on these bonds is adjusted semiannually, on May 1 and November 1.)
Treasury Bills (as of October 5)
4-week T-Bill - 2.20%
13-week T-Bill - 2.21%
26-week T-Bill -2.20%
(To monitor interest rates on T-Bills, visit the treasury's statistical release site (http://www.federalreserve.gov/releases/h15/current), which is updated every Monday.)
Credit Unions: According to the August survey of credit unions, banks and thrifts conducted for Bankrate.com, your can find some of the best rates on savings products at credit unions. In checking the averages, Bankrate.com found that the average credit union yield for a one-year CD was almost a full percentage point higher than that offered by banks, and nearly a half-percent better than what thrifts are offering. Average yield rates for money market accounts at credit unions was nearly 1.25 percent better than what banks offer, and more than a half-percent better than the thrift average. In a nutshell, credit union members have an edge when it comes to higher yields.
What About Safety?
If you're reluctant to move your money to higher-yielding accounts because you're worried about easy access or safety, don't be. Like traditional passbook accounts, money market accounts and CDs are insured by the Federal Deposit Insurance Corporation or the National Credit Union Administration. And U.S. Savings Bonds are fully guaranteed by the federal government.
Concerned about Early Withdrawals?
There are penalties for early withdrawal from CDs and savings bonds, but they're typically only several months' lost interest. And consider the ways you can avoid having to withdraw your money early. You can keep a small emergency fund in a money market account. Or you can "ladder" your higher-yielding investments so that you've got a CD or bond coming due as often as every month. For example, if you have $1,000 in savings, you could put $250 into a different 3-month CD every month for four months; that way, you would never have to wait longer than a month to gain access to part of your money. The same is possible with savings bonds. Money market accounts give you instant access to your cash.
Upping the Bottom Line for Savers
There are lots of ways to structure your savings so that you earn higher yields while keeping your money safe and available. Depending on your situation, a combination of options may meet your needs best. While some savers worry about investing in a product or institution they are unfamiliar with, the biggest danger to their financial well being may be apathy. As Daniel Ray, editor-in-chief of Bankrate.com, says, "Passbook savings accounts are passé. If you haven't checked your interest rates lately, you're throwing your money away."