Last month, my friend Brad and I grabbed coffee at one of our favorite spots in town. I hadn’t seen Brad in what seemed like months. I suppose that’s to be expected when your friends start having kids. “How’s being a dad?” I questioned. With bags under his eyes, Brad answered “Tiring and expensive, but I love the little guy.” That’s when we started talking about financing his child’s future. To my dismay, I found out Brad had an unnecessarily large sum of money in a savings account.
Don’t get me wrong, savings accounts are a far better option than storing cash under your mattress or in some cliche emergency fund jar. While the principle behind a savings account is good, the interest you earn is unfortunately terrible. According to the FDIC, the national savings account interest rate was a laughable 0.09% APY (annual percentage yield). Of course, this can fluctuate depending on a multitude of variables. For instance online banks typically offer higher yields (up to 1.9% APY), compared to traditional brick and mortar banks. Another consideration is the minimum amount you agree to hold in your savings account in return for a higher interest rate. For example, bank “A” might give you an additional 0.25% interest rate if you agree to have a minimum of $100,000 in your savings account. My favorite abysmal example is the current yield on a CD (Certificate of Deposit). A certificate of deposit is basically a financial instrument where you agree to loan your money for a specific time frame. If you bought a 60 month CD at the beginning of 2020, you would only realize 0.97% APY over the course of 5 years!
Dip below that $100,000 minimum or terminate your CD early and you’ll be hit with all sorts of inconvenience fees. All of this doesn’t sound too bad, albeit you might not be earning high interest, but its better than nothing… right?
Wrong. Often times, people forget about the time value of money and inflation. Inflation is defined from an economical sense as “a general increase in prices and fall in the purchasing value of money.” Let’s use a simple example to demonstrate inflation and how that compares to the interest you earn from a savings account.
Pretend that you have $5 in your savings account today. At the same time, a bag of oranges also costs $5. Great! You can afford to buy that bag of oranges. According to the Bureau of Labor Statistics, the US national inflation rate between 2018 to 2019 was 2.3%. Meanwhile, your savings account is only earning you 0.09% interest rate APY.
Fast forward 1 year. Now your $5 is worth $5.0045 ($5 * 1.0009) due to your savings account interest rate.
But now that bag of oranges actually costs $5.115 ($5 * 1.023) due to inflation.
You can no longer afford to buy that bag of oranges because your savings account interest rate was yielding something lower than the inflation rate! You lost money. This is a common phenomenon with people I talk to, including Brad. It seems like a trivial amount; often times it goes unnoticed. It seems like you actually made money. And that’s the way the banks want you to think. In actuality, it’s the opposite. Even worse, consider the annual fee you might’ve paid the bank for your savings account or the fact that your losses are compounding every year you maintain that super low interest rate.
Isn’t the whole idea infuriating? The whole purpose of a savings account is so you can use those funds in the future. But what good is that savings account when it’s losing money? Here’s the good news. We don’t have to settle for savings accounts, money markets, or CDs. There are alternative securities that can achieve the same goals with higher interest rates.
One of my favorite recent financial revolutions is the rise of Robinhood. This is the first mainstream DIY brokerage account that allowed the public to trade stocks and other securities, commission free. They were so successful that traditional brokerages like TD Ameritrade were forced to also allow commission free trades on their own platforms, just to stay competitive. We invest in stocks and bonds because we believe those companies and municipalities will eventually use our investments to create value. Value in the sense of stock appreciation or dividend payouts. The concept is no different than opening a savings account. With a savings account, you’re giving your bank money so they can loan it to others and create value. The secret is when the banks loan out your money, they’re collecting an interest rate much higher than the measly 0.09% they offer you. Interest rates sometimes in the double digits… while you’re lucky if they cut you 2%! That’s why DIY brokerages are my personal favorite investment alternative. You have thousands upon thousands of options like mutual funds, ETFs (electronically traded funds), ETNs (electronically traded notes), stocks, bonds, etc. No more questioning which bank is going to give you the best interest rate on your savings account because truthfully, they’re all competing on marginal 1/10th of percentages anyways.
But wait, aren’t brokerages riskier? Plus, who has time to manage it and research which securities are right for me? The answer to those questions is, it certainly can be riskier and more time intensive. But it also doesn’t have to be, it’s up to you. That’s the beauty and flexibility of brokerages. Online brokerages like TD Ameritrade are FDIC insured, just like your bank. The stock market also has a bunch of investment vehicles that are built specifically to be low risk and stable over time. Yet, earning a return that’s much better than a savings account. It’s liquid, just like your savings account so you can pull money out if you need it. Opening an online brokerage account is so easy, it takes the same amount of time to open a savings account.
For those of you who might feel intimidated by the process, these brokerages also offer you online help, phone support, and can even refer you to financial planners if you don’t feel like you have the time or education to research the right investments for your situation (for a fee of course). Financial planners are experts at understanding your risk appetite and pairing that with the right investments to help yield you the highest returns possible.
Chances are you probably have a 401K, IRA, or some sort of retirement account. If you’re still questioning the validity of a brokerage account… guess what? You’re already participating in something very similar through your 401K! Your 401K is investing your money into mutual funds, stocks, bonds, etc to appreciate your assets for the future. Simplistically, it’s the exact same reason you opened a savings account. You might enjoy keeping a savings account and depending on your situation, it could very well make a lot of sense. Maybe you want to have some emergency funds on hand that are more liquid than a brokerage account. Maybe, you have a unicorn savings account that is returning you something higher than the national US inflation rate. At the end of the day, everybody’s financial situation is different. It’s up to you to decide where you want to allocate your assets.
But don’t forget that there are other options for you to grow your money. Brad and I speculated what college tuition would look like by the time his child reached 18. It was scary. If your savings account isn’t at the very least beating inflation rates, it’s probably time to ask yourself. “Is it worth it?”