Seasoned investors know that the higher an investment's risk is, the higher the potential return will be. Because a bank savings account is extremely low-risk, the return (in the form of interest) you can expect to receive from such an account will be equally low. This is particularly apparent in today's low-interest rate environment; it's not uncommon these days for bank savings accounts to return as little as 0.01% interest.
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Why you need savings regardless
In terms of return on capital, savings accounts don't make much sense as an investment. However, there are other factors that make them wise investments. Keeping a stash of cash is an important part of any investing plan, because it gives you far more flexibility. First, if you have a sudden unexpected opportunity to buy into a really great investment, you don't want to have to pass because you're cash-poor. And second, keeping cash around for emergencies can save you from having to run up credit card debt in a crisis and thereby end up with fees and interest payments that will cancel out your investment profit. Fortunately, brick-and-mortar bank savings accounts aren't your only option for storing cash.
No matter where you keep it, you should always have cash that you can access on short notice. Image source: Getty Images.
An internet-only bank can typically offer a better interest rate, because such banks have less overhead than brick-and-mortar banks. They don't have to spend the money to maintain physical branches, and they can return part of those savings to their customers. Ally Bank is one well-known example of a pure internet bank. Other banks have gone the hybrid route, having a small handful of physical branches but doing most of their business online. Dime Community Bank has taken this approach: It has 27 physical branches in New York City, but as an internet bank it serves the entire country. If you happen to live in the vicinity of such a hybrid bank, you can get the best of both worlds: a relatively high interest rate and the convenience of a physical bank location. As of this writing, the best internet banks are offering between 1.05% and 1.15% interest rates on savings accounts. That's not exactly a terrific return compared to other investment options, but it's over 100 times better than what many brick-and-mortar banks are offering.
Certificate of deposit (CD)
A bank CD is a timed deposit: It's like a savings account, except you can't access the money until the specified time runs out (unless you're willing to pay a penalty). The term on a CD can range from a few months to several years, with longer-term CDs typically offering higher rates of return. If you decide to use CDs as a replacement for a savings account, you can increase the liquidity of these investments by splitting your savings between several different CDs that mature at different times. For example, you might put $1,000 into a six-month CD each month for six months, meaning you'll get part of your money back every month once the first CD term runs out. However, given that the return on short-term CDs is only marginally better than the return on internet savings accounts, and given the hassle of having your funds tied up in a less liquid account, CDs are not a great savings-equivalent option in the current market.
Treasury bills are the short-term equivalent of Treasury bonds: They're a way to lend your money to the federal government and receive interest payments in return. Typically you'll buy a Treasury bill at a discount and receive the bill's face value when the term runs out. For example, you might buy a $100 treasury bill for $98, then receive $100 when the term expires; the extra $2 is your interest on the loan you made to the federal government.
Terms for Treasury bills range from a few days to one year. Of late, Treasury bills have been returning significantly less than internet bank savings accounts (as of today, the three-month treasury bill rate is 0.78%). However, they do have one stellar advantage: Your returns on a Treasury bill are exempt from state and local taxes. If you live in a state with high income taxes, this may make Treasury bills a better choice than a savings account.
The myRA is actually intended as a retirement account, but it makes a nifty option for storing your cash. MyRA is a special type of Roth IRA managed by the federal government. Any contributions you make are invested in a U.S. Treasury retirement savings bond, the same security that government employees have in their Thrift Savings Plan retirement accounts. The fund earned 2.375% during April 2017 -- an excellent rate for a security backed by the Treasury Department. Because this is a Roth style account, you can withdraw the money you've contributed at any time, but you'll pay penalties if you withdraw any earnings before age 59-1/2. All in all, it makes a pretty stellar alternative to a conventional savings account.
Choose the account you'll use
The most important part of choosing a savings account is the part where you actually put in money. If you just don't have the time or inclination to shop around and explore these alternatives, then stick with a standard savings account. As long as you're putting money somewhere, you're doing the right thing.
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