High Interest Savings Accounts: The Best Thing Since Sliced Bread?

There’s no question that the world and the economy have taken us on a wild ride lately. For many, the financial news regarding high inflation and economic uncertanty can feel disorienting and even worrisome at times. And so I feel it is important for us to have a better sense of what is going on and what, if anything, we can do to take advantage of times like these. 

Fortunately, I come bearing good news and some clarity amidst the chaos. Let’s explore.

So What Happened?

When I started The Personal Finance Playbook in the summer of 2017, I talked about the importance of investing in the stock market to outpace this thing called inflation. Some inflation is a natural part of a healthy economy and is measured by the increase in the price of goods and services year over year. 

Remember those five dollar footlong ads from Subway? Good luck being able to buy one of those sandwiches for $5 today. That’s inflation. 

Back in those days, I called inflation the sneaky money eating monster because if you keep all of your money in cash, the price of goods and services will slowly increase over time and eventually erode your money’s purchasing power. 

But as you know, inflation has not been so sneaky lately. In 2022, according to Consumer Price Index data, inflation hit its highest levels in over 40 years. The sudden and dramatic price increase of groceries, home prices, gas prices, used cars, airfare, furniture and many other things made inflation a main storyline and problem in the United States and many countries around the world.

How Did Inflation Get So Bad?

When the demand for goods and services is greater than the ability to supply those goods and services, the price of those things increases. And a few big global events weakened the ability to supply such as the Covid pandemic, China’s prolonged lockdown, Russia’s brutal invasion of Ukraine as well as several other factors. This made it more difficult for countries and companies to supply goods and services as efficiently as they had previously.

For example, Russia has been one of the largest oil producers in the world, which fuels our cars and heats our homes. After its attacks on Ukraine, much of the world stopped buying from Russia, removing a large amount of oil from the global supply. This caused oil prices and gas prices to increase to compensate for the lower supply.

Another example: imagine you own a successful cell phone company and employ thousands of people in the US. You have kept the price of your phones competitively low because of your great relationship with manufacturers in China who make the microchips for your phones cheaply and efficiently. But once the pandemic hit and China went into a prolonged lockdown, the production of the microchip factory slowed substantially. So now you have less cell phones but if you sold them at the same low price, your revenue would not be enough to pay your staff. So you have no choice but to raise the price of your phones to compensate for the slowing supply from China.

Supply slowed down in many areas across the economy. And as Covid lockdowns were lifted in the US and in many other places, people began buying again just like before, but the increase in purchasing was happening faster than the slowing supply chain could handle.

And when there is less supply of the goods people want and need coupled with their steady and increasing demand, it causes prices to increase. The more dramatic the gap, the bigger the price increase.

In other words, inflation was no longer humming at a modest 2-3% a year, it was screaming at over 9% by June 2022. This means the average price of goods and services in the US had risen 9% from the previous year.

The Story Of The Fed

The Federal Reserve (also known as the “Fed”) is the central banking system of the United States and acts to keep the US economy balanced when things start getting out of whack. One of the “pull in case of emergency” levers it uses to keep things balanced is the ability to raise or lower interest rates. It does this to either help boost the economy or put the brakes on it.

When the economy is in a recession like it was after the 2008 financial meltdown, one of the things the Fed did to help revitalize the economy was to lower interest rates over time. When this happened, things like mortgage rates went down, interest on savings accounts were lowered, and interest rates on car loans and business loans were reduced* as well. 

As a result it became much easier for people to buy a home with lower mortgage rates, cheaper for businesses to expand and hire with lower loan interest rates, and we were less incentivized to save because the interest rates on bank savings accounts were near rock bottom, which encouraged more spending. 

When interest rates become lower, it encourages people not to save, but to spend and pump money into the economy. “Don’t wait, now is the time to get that car you’ve always dreamed of with lower financing!”

It’s a lot easier to keep up with the Joneses when interest rates are low.

How Low Can You Go?

Interest rates stayed historically low for well over a decade which helped bring the US economy out of its recession and saw a boom in the stock market, housing market and job market during that time. 

Then, when the pandemic arrived and overstayed its welcome, the economic machine hit a snag. Supply chains were negatively affected and demand outpaced supply in many areas, which increased the price of goods and services dramatically and quickly. 

So in response to the outrage over ultra high gas prices and soaring home prices and rapidly rising inflation, the Fed went back into its toolkit and began raising interest rates to slow down economic activity.

So now, houses became more difficult to buy with rising mortgage rates, and it became more expensive for businesses and individuals to take out new loans. The goal here was to gradually slow the amount of money flowing into the economy to bring demand for goods and services down to ultimately lower prices and tame inflation. 

And while inflation is currently still way above pre-pandemic levels of 3.5%, it is expected to be lower in 2023 than it was in 2022. 

Good News For Savings Accounts

While it is definitely more challenging to buy groceries, fill up your car with gas or take out a loan these days, there is a hidden benefit that comes when the Fed raises interest rates. 

As I mentioned before, when the Fed lowers rates, the interest rates on our savings accounts go down to encourage us to spend. But when the Fed raises rates, the opposite happens. The interest rates on savings accounts go up to encourage saving over spending. The Fed has raised rates quite aggressively which makes saving much more enticing, if you know where to look. 

Unfortunately, more traditional banks such as Chase and Bank of America have kept the interest rates on their savings accounts ridiculously low around 0.01%. However, online or mostly online banks like Ally Bank and Capital One** offer interest rates on their savings accounts that are currently around 3.40%. 

Meaning, if you kept $10,000 in a Chase savings account, you would receive $1 in interest per year. Congrats. However, if you kept $10,000 in an Ally Bank or Capital One savings account, you would receive approximately $340 in interest payments per year.

$1 vs. $340 in free money? That is quite a raise for doing nothing!

One of the reasons these banks can offer higher interest payments is because they are either entirely online (Ally) or in the case of Capital One, they are mostly online with a modest retail presence. Instead of paying for all that office space and retail staff, they can pass those savings onto their customers. 

Even in times of low interest rates, banks like these have historically offered higher interest rates on their savings accounts than their more traditional competitors. 

Going With The Flow

As of March 2023, the savings rates for Ally and Capital One are around 3.40%, but that can and will go up and down over time. When I first started the blog, these same banks had interest rates around 1%, but since the Fed started raising rates, their interest rates have gone up with it. 

So if you have a savings account, the interest rate on that account will fluctuate over time, but at this moment it’s pretty great.

One of the fun things Ally Bank does is they enthusiastically email their customers every time the interest rate on their savings account goes up. I’ve probably gotten a dozen of them in the last 18 months. In fact, while writing this post, I got an email from Ally. 

The title of the email was “We’re Running Out Of Ways To Say Your Rate Is Going Up”.

What Are Online Savings Accounts Good For?

These accounts are great for things like an emergency fund which is a place to stow away enough cash where you can easily pay for 3-6 months of expenses in case of a job loss or other financial emergency. Savings accounts are also a great place for shorter term savings goals such as the down payment on a home, saving up for a vacation or wedding or anything that you plan to pay for in the next 3 years or so. 

You can even set up multiple accounts such as an Emergency Fund, a Travel Fund, and a House Fund. These online accounts are separated from your checking account which helps you to refrain from using it until you need it. And these accounts will not lose money which makes it great for shorter term goals. 

In fact, checking or savings accounts with most banks are FDIC insured up to $250,000 meaning in the unlikely (but not impossible) event the bank is irresponsible with your money, you will be insured up to $250,000. Make sure any bank you are a customer with offers this added protection. 

One Thing To Note

While these savings accounts are great for the short term, it is still important to be invested for longer term goals in order to build wealth and outpace inflation over time. Investing in the stock market comes with greater risk, but as this blog has talked about many times, it is one of the best tools for long term financial security. 

So some mix of checking, savings and investment accounts is the sweet spot. A traditional checking account for your immediate cash needs, high interest savings accounts for emergencies or short term savings goals, and investment accounts for their long-term wealth building potential.

So What’s The Catch?

Surprisingly, there really isn’t one. These two banks make it easy to set up one or multiple savings accounts online with no fees attached.

The only thing to be aware of is that any interest you earn from savings accounts, no matter the bank, is considered taxable income. Meaning if you have $10,000 in a savings account and it earns $340 in interest this year, you will need to report that $340 amount on your taxes. 

But in my opinion, this is well worth the price of admission. Paying taxes on free money sounds a lot better than paying no taxes on no free money. 

Conclusion

This has certainly been a challenging time in history. A global pandemic, generationally high inflation and economic uncertainty have made life difficult for a lot of people financially and emotionally. 

But the stock market has been able to rebound from this as it has with all previous storms, and high interest savings accounts continue to benefit from the Fed’s goal to systematically raise interest rates to fight inflation. These are powerful financial tools we can use to help navigate times like these.

So are high interest savings accounts the best thing since sliced bread? I don’t know. But what I do know is that since the cost of sliced bread and many other things have gone up quite a bit lately, now is as good a time as ever to add this type of account to your financial plan and start generating some free money for yourself. 

You deserve it.