Beware the “High-Yield” Savings Account
When I wrote the first edition of Personal Finance for People in Tech nearly a year ago, it seemed silly to include material about cash savings. At the time, the stock market had been booming for about a decade straight, and holding cash for anything other than emergency use seemed foolish. Now, cash is king once again, and there’s newfound interest in hunting for the best yield. Chasing yield with a “high-yield” savings account isn’t a good long-term strategy. Consider some alternatives.
The yield on any investment is the amount of income it provides you as a percentage of your principal. Until recently, savings accounts offered less than 1% interest in the U.S.; depositing $10,000 would yield less than $100 per year. Now, some banks and credit unions are teasing depositors with 3%, 4%, or even 5% interest; on a $10,000 deposit, you might expect to get a few hundred dollars more. Cash deposited in a bank is insured by the FDIC for up to $250,000 per depositor per bank. Credit union deposits are likewise insured by the NCUA. This means that if your bank or credit union fails, you’ll get your entire balance back. Your interest rates, though, are not guaranteed to last.
Back in the late 2000s, I signed up for a high-yield account with HSBC that paid 5% interest. After a couple of years earning that high rate, I started to receive near-monthly messages entitled “An update regarding your Online Savings Account” from HSBC. Every one included a new interest rate, lower than the month before. HSBC’s problems with anti-money laundering compliance hurt the bank’s financial picture further. I ended up closing my account after its annual interest rate fell from 5.00% to 0.50%, a 90% drop in yield; later on, that yield fell another 90%, to 0.05% interest per year.
Some banks offer teaser rates to entice people to deposit new money. I’ve seen some “high-yield” accounts in the past year that have significant limitations. Several apply the teaser rate to only the first few hundred dollars or few thousand dollars of deposits, then pay little or no interest on deposits beyond that. In some cases, depositors have to Direct Deposit some or all of their salary every month to qualify for the teaser rate. In others, depositors have to use their debit card a certain number of times per month — that can be annoying for customers who prefer to use a cash-back credit card instead. Sometimes, a teaser rate requires a customer to refer other customers to the bank or credit union; unless you have a list of like-minded friends, this turns you into a sales rep. In all cases, the teaser rate is never guaranteed; it can decrease at any time. When you see a teaser rate, read the fine print and understand what you need to do to qualify. If you get an extra one percentage point of interest, that’s $100 of taxable income on $10,000 deposited; is your time and effort worth the $60 to $70 you’d net after taxes?
Renaming accounts is a common way that banks tease high rates for new customers without benefiting their existing customers. For example, I qualified for a 5% interest rate by opening what HSBC at the time called a “Direct” savings account. Later, they renamed my account to an “Advance” account as my interest rate ticked down, month after month. After I closed my account, they introduced a new “Direct” account with a higher rate, but customers who had “Advance” accounts weren’t automatically switched to it. Customers had to specifically ask the bank to switch their account, if they qualified for it.
Neobanks are tech startups that look like banks, and that sort of work like banks, but are not necessarily insured like banks. In some cases, they hold funds in an FDIC-insured institution, but in the name of the neobank, not in the neobank customer’s name. Neobanks have offered high interest rates, but with requirements and restrictions that have caused problems. Beam Financial, for example, promised both FDIC insurance and 7% interest — way more than what traditional banks paid at the time — but it was shut down after some customers complained that Beam wasn’t fulfilling requests for withdrawals. Chime, which describes itself as a “consumer software company”, agreed to stop calling itself a “bank” after complaints from California regulators. Other neobanks have specialized in cryptocurrency, promising high interest rates but without any form of insurance, and have lost billions of dollars of customer deposits in just the past half-year. Because there isn’t much settled law about cryptocurrency, people who put their crypto on deposit with companies like Celsius and FTX might have to endure years of court battles before they get even some of their assets back.
Emergency funds are best placed in an account with a reputable bank or credit union that you can access easily, such as through ATMs near you, or by making free online transfers and bill payments. If you have your emergency expenses covered for a few months in an easily accessible account, there are a few other places where it’s safe to store cash.
Money market accounts (MMA) are offered by banks and credit unions and may pay higher interest rates than savings accounts at the same institution. If you have a savings account that’s paying little or no interest, check your institution’s web site to see if they offer an MMA. Moving funds from a savings account to an MMA at the same institution won’t require a credit check and can be done in just a few minutes, online or over the phone. MMAs are FDIC or NCUA insured, so you won’t lose your principal if your institution fails. As with savings accounts, you are expected to make withdrawals from an MMA only rarely; your institution may limit you to 6 withdrawals per month, and they may charge you fees if you exceed this limit. As with a savings account, your interest rate in an MMA is not guaranteed; it may go up or down at any time.
Money market funds are not the same as an MMA; these are offered by brokerage accounts, and they often look and work like MMAs and savings accounts, with higher yields than both. The major difference is that while an MMA is insured, a money market fund is usually not. A money market fund looks and works like a mutual fund with a share price of $1.00, and it pays interest or dividends every month, which get reinvested back into the fund. The risk of a money market fund is that it can “break the buck,” by having its share price go below $1.00. If a money market fund breaks the buck, shareholders/depositors will lose money. Breaking the buck is extremely rare; during the 2007–2008 financial crisis, the U.S. Treasury Department offered extra assurance for institutions to protect money market funds against breaking the bank, and no depositors lost a penny. As with savings accounts and MMAs, money market funds’ yields can go up or down at any time.
Bond funds invest in a variety of debt, including U.S. government debt instruments like Treasury bills (T-bills), T-notes, and T-bonds. You can also buy bonds directly from the Treasury using their free, yet clunky, TreasuryDirect web site. You can also buy bond funds from your broker. The 10-year T-note is considered a benchmark for the economy; in early February 2023, it paid 3.738% interest per year, nearly double its rate from a year before. As with bank interest, most bond interest is taxable income. You might be able to save money on your taxes by buying tax-free bonds, such as municipal bonds (or “munis”), in a taxable account. If you live in a state with an income tax, buy a muni bond fund carefully, so that you avoid both federal and state taxes. Bond funds are not insured and may increase or decrease in value. If you buy a 10-year note, your rate is locked in for the duration, but if you buy into a bond fund that trades debt every day, your yield can vary daily.
CDs typically offer a higher yield than a savings account and don’t have teaser rates; a CD’s rate is locked in for the duration of its term, and can’t go down. (Some banks have offered CDs whose rates can increase, although I haven’t seen any recently.) The advantage of a CD is that your funds are FDIC or NCUA insured, just like a savings account is, so that you can get your principal back if your institution fails. (You might not get all the interest, though, in that case.) The main disadvantage of a CD is that your funds are locked away for the term. You can build a CD ladder of, for example, CDs whose terms end every month or every three months, so that you’re never too far away from having at least some of your money available. Fidelity Investments, of which I’m a client, offers brokered CDs and has tools to set up CD ladders more easily. Brokered CDs, for reasons I don’t understand, are sold by banks to brokerages like Fidelity, and they offer much higher yields than the same banks offer to their own depositors. At a time when Chase offered me a 3.25% yield on a one-year CD, for example, Fidelity sold me a Chase CD yielding 4.75%. Brokered CDs can be resold, possibly at a higher or lower price, if the owner needs cash immediately. Some brokered CDs are callable, meaning that it’s possible that a bank could “call” the CD by paying the principal and some, but not all, of the interest; callable CDs offer higher interest rates, but buyers accept a little more risk than if they buy a call protected CD.
Lastly, consider I Bonds, which are only available from TreasuryDirect. I Bonds are 30-year bonds that pay a fixed rate (currently 0.40%) and a variable rate (currently 6.48%) that adjusts every 6 months based on inflation. I Bonds’ yields can go up or down, but they never go below zero. Each U.S. person can buy $10,000 worth of electronic I Bonds online, plus up to $5,000 worth of paper I Bonds using the proceeds from their federal income tax refund. After one year, a bondholder can cash in an I Bond and forfeit three months of interest. After five years, they can cash in an I Bond and get all the interest that has accrued so far. After 30 years, the I Bond will stop earning interest entirely. Unlike with a bank account or Treasury bond, the interest is only taxable income when the holder cashes their bond in. I Bonds have great rates, and after you hold them for one year, they might even be suitable for storing some emergency funds. Just be aware that it’s more time-consuming to cash in an I Bond than it is to withdraw cash from an ATM.
In the long run, equity investments such as stocks have outperformed all other U.S. asset classes, and they grow faster than inflation. Stocks can rise in price and can generate dividends from business operations. Even a “high-yield” cash investment is unlikely to keep up with inflation. If you’re looking for places to stash some cash for emergency expenses, or for a big short-term spending goal like a mortgage down payment or a college tuition bill, consider all your options for saving your cash wisely and safely.