Think like a bank to earn more money!
Elliot Pepper, CPA, CFP?, MST
Financial Planner & Director of Tax Services
We all feel the pain of the post-pandemic “inflation hangover,” and lingering high prices continue to impact personal budgets. The US Federal Reserve has aggressively raised interest rates and kept them there for some time now. The goal of this policy should have positive long-term benefits of lowering inflation and avoiding currency devaluation, but that is little solace for people struggling today with higher interest rates on all forms of debt including mortgages, car loans, student loans, and credit cards.?
Ensuring your hard-earned money is safe and working for you is more crucial than ever. While it might be tempting to stash your cash in a regular savings account for its accessibility and perceived safety, this choice often means missing out on significant interest earnings. Instead, opting for an FDIC-insured account that offers a higher yield can substantially affect your financial health over time.
Think like the bank!
Consider how a traditional bank makes money. Contrary to how Gringots, the mysterious financial institution from the Harry Potter series, operated, customers’ deposits do not just sit in a vault guarded by dragons. The bank will take your money and lend it to someone else and charge them interest.? A bank’s primary profit is the difference between what it must pay to borrow money (from depositors like you and me) and what it can earn in interest on loans made to people who need to buy homes, cars, or start businesses.? Since most people keep their money in zero or near zero-yielding bank accounts, banks can “borrow” cheaply and lend out at a much higher interest rate. For example, if I have $25,000 in a basic checking account earning no interest, the bank can lend it to my neighbor to buy a new car at a 7% annual interest rate. The result? The bank makes a profit of $1,750 after 12 months ($25K x 7%), my neighbor has a $25,000 debt and a depreciating asset, and I get nothing. But wait, it’s our money that the bank is using to generate all this interest income! Why aren’t we getting a piece of that income?
When you deposit money into any bank, you are essentially making a loan to the bank because you can demand that the bank pay you back for whatever balance is in your account. The ability to quickly, safely, and securely withdraw money is a valuable service that banks offer to customers. I recommend that everyone utilize a free checking account to facilitate cash inflows and outflows, even if it does not earn interest. The important concept here is about what to do with excess savings you want to keep safe and secure but do not need to pay this month’s bills.?
Understanding the Basics
Ensuring your hard-earned money is safe and working for you is crucial. Opting for an FDIC-insured account that offers a higher yield can substantially affect your financial health over time.
FDIC Insurance: The Federal Deposit Insurance Corporation (FDIC) insures bank deposits up to $250,000 per depositor, per insured bank, for each account ownership category. This means that even if the bank fails, your money is protected.
Interest Rates: The interest rate is the percentage of your deposited amount that the bank pays you for keeping your money with them. Higher interest rates mean more money for you without any additional effort.
Regular Savings Account vs. High-Yield Savings Account
A regular savings account typically offers minimal interest, often around 0.05% APY (Annual Percentage Yield). In contrast, a high-yield savings account can offer rates around 4.00% APY or higher, significantly boosting your earnings.
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5-Year Comparison: Regular Savings vs. High Yield Savings Account
High-Yield Savings Account:
As illustrated, a high-yield savings account significantly outperforms a regular savings account over five years. By choosing an account with a higher interest rate, you can earn over $5,000 more, ensuring your money grows steadily while remaining accessible.
Keeping your money in an account that earns meaningful interest helps combat inflation and increases financial security. High-yield savings accounts offer a risk-free way to make your savings work harder, providing both safety and growth.
Conclusion
Choosing where to keep your savings is a critical decision impacting your financial future. While regular savings accounts offer convenience, high-yield savings accounts provide a much-needed boost in earnings without sacrificing security. By prioritizing accounts with higher interest rates, you ensure your money is not just sitting idle but actively contributing to your financial well-being.
The information contained herein is intended to be used for educational purposes only and is not exhaustive. Diversification and/or any strategy that may be discussed does not guarantee against investment losses but are intended to help manage risk and return. If applicable, historical discussions and/or opinions are not predictive of future events. The content is presented in good faith and has been drawn from sources believed to be reliable. The content is not intended to be legal, tax or financial advice. Please consult a legal, tax or financial professional for information specific to your individual situation.
This content not reviewed by FINRA
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