If there’s one thing personal finance experts can agree on, it’s the benefit of a high-yield savings account. They’re easy to open online with no fees, and can help grow your savings through interest earnings.
But circumstances are different this year.
In just a few months, following the coronavirus pandemic and ensuing recession, high-yield savings account rates have fallen from 10-year record highs above 2% to much more modest ranges. Many now hover between 0.70% and 1%.
In times of need, savings are a lifeline for many Americans, and even a partial emergency fund can make all the difference. But this year has also highlighted the ways in which a strategy reliant upon scoring the best interest rate may not be enough.
“The goal of a savings account isn’t to make money on the interest — that’s what investing is for,” says Ramit Sethi, New York Times bestselling author and founder of Iwillteachyoutoberich.com.
In fact, as savings rates continue to fall, experts say, the amount earned on a few thousand dollars in a savings account should be the least of concerns for Americans, especially those who are struggling most.
What’s Going On, Anyway?
Low interest rates are part of the Federal Reserve’s broader policy to keep the economy afloat, which is similar to the stance it took following the 2008 financial crisis.
During economic downturns, the people tend to save more of their money due to uncertainty, so low interest rates help get money into the economy as opposed to leaving it sitting in savings accounts. They spur business activity, promote consumer spending, and help businesses and consumers access low-interest loans.
At least in theory.
In reality, business activity is still slow, spending is down across various categories, and Americans are saving more than ever before.
“As long as people are afraid, as long as the U.S. is unstable, the virus is not contained, and the job situation is not under control, people will continue to save,” says Sarah Nadav, a behavioral economist and author of “What the F*ck Should I Do Now?” a guide to managing money in the time of COVID-19.
For some, a zero-bound, low interest rate environment may be inconvenient, but won’t have much impact. Those with stable income and assets can simply maintain their saving strategy without much regard to rates. They might even benefit from low rates as borrowers, by refinancing their mortgages at a lower rate or qualifying for lower-interest loans and credit lines.
But some experts, like Nadav, are critical of how low interest rates can leave behind small savers: people without the means to take advantage of low-interest loans as borrowers who may be facing financial hardship.
On a broad scale, low interest can help avoid economic collapse — which is obviously beneficial for everyone — but that tradeoff comes at the expense of these individuals. Some accounts may no longer even keep up with inflation, over time.
“These low interest rates benefit people who have a lot of money,” Nadav says. “They don’t benefit the average small saver significantly.”
Small savers are also the least likely to benefit from low rates as borrowers. Tightened lending standards ensure that only those with the best credit scores will be able to access low-interest loans and lines of credit, so people already facing hardship will see little assistance from low rates on their credit cards or personal loan balances.
“You can expect that the average American, especially those who are already going through unemployment, will have a major hit to their credit score at some point,” Nadav says. “And once that happens, they’re not going to be able to take advantage of any of this. They’ll be locked out for the duration.”
So, What Can You Do?
For people facing severe hardship or persistent unemployment, frugality is not enough, especially as a second stimulus and extended unemployment benefits from Congress remain uncertain.
Now is the time to stop chasing pennies on interest rate earnings or relying on small budget changes that don’t make any real difference in the long run.
“I don’t want people to start making really intense decisions when they’re in debt and over their head,” Nadav says. “I’d rather they stand here now, look at what they have in the bank, and assume the worst so that they’ll be in the best position.”
Forget Interest, But Continue Saving
Your savings account’s interest rate isn’t going to get you ahead anytime soon, but don’t let that stop you from saving money.
Prioritize building your emergency fund, even if you can only contribute a few dollars each month. Choose an account that aligns with your long-term goals and focus on building your savings cushion to a place that you’re comfortable with.
In times of uncertainty, cash is king, Sethi says. He recommends aiming to cover one full year of expenses.
Even as they approach all-time low APYs, or annual percentage yields, a high-yield account with an online bank is still your best option. A relatively modest 0.80% interest rate is far better than the 0.05% national average, and when the Fed begins raising rates again, online banks will be among the first to follow.
Start Making Bigger Changes
Even if your situation isn’t dire — maybe you still have a couple months’ expenses in savings or you’re getting by on unemployment insurance — having a plan now can keep you from being left in a worse position later.
And that plan needs to go beyond small solutions like cutting down on takeout and reducing your online shopping totals.
“That’s not helpful; it’s actually harmful,” Nadav says. “That perpetuates a level of denial where you can think, if I just cut down on these purchases and put money in my bank account, then I’ll be okay.”
Which substantial recurring expenses (think utility payments, auto loans, subscriptions) can you reduce or defer? What medical or nutrition assistance programs are you eligible for? Can you take on roommates or move in with a loved one to save on housing costs? Is there any available work you might qualify for, whether as a career change or temporary role?
Making these big-picture financial decisions can help you settle into a position today where you can at least maintain, rather than fall behind.
“One of the cardinal rules of personal finance is this: Live to fight another day,” Sethi says. “Do not put yourself in a situation where you’re forced to make decisions with your back against the wall.”
For those most affected by the pandemic, though, individual action is often not enough. Broader, extended economic stimulus — and a solution to today’s unemployment crisis — is necessary, Nadav says.
On top of the hit to any savings they might already have, those with the least amount of money coming in are still spending nearly as much as they were before the pandemic, despite record savings deposits overall.
A recent NextAdvisor survey found that the majority of unemployed Americans are using unemployment insurance simply to meet necessary expenses, with little left for saving — and that was before the extended $600 federal benefit expired in July.
“When people who need money get money directly into their accounts, they spend it,” Nadav says. “That stimulates the economy dollar-for-dollar or more. They’ll spend it, and they’ll often spend it locally. It’s a virtuous cycle.”
Looking Ahead: How Low Will Rates Go?
Federal Reserve officials predict today’s rates will remain through at least 2022, as the economy slowly recovers.
Since the federal funds rate — which banks use to determine the interest rates they set — dropped to a target range of 0% to 0.25%, interest on everything from mortgages to auto loans, credit cards and deposits has fallen in turn.
For someone with a $10,000 account balance, the difference between 2% interest in 2019 versus 0.80% today means a $120 yearly drop in interest earnings.
The only other time the Fed’s target rate fell this low was in late 2008, during the financial crisis.
“We’ve seen a collapse of rates much more severe than what we saw then,” says Ken Tumin, founder of DepositAccounts.com, a site that tracks deposit interest rates. “When the Fed dropped to that zero bound, we didn’t see the bottoms of a lot of these online bank rates until about 2012 or 2013. Compare that to this time; in a matter of months we’ve seen a lot of all-time lows at several of the online banks.”
Because banks have reacted much more quickly this time around, Tumin predicts rates will bottom out closer to 0.50%.
Light At the End of the Tunnel
Savers may not have to wait for the Fed to make moves in order to see positive action on their savings accounts, though. In 2013, some banks began raising rates again even as the Fed held low; and there’s reason to assume we may see similar moves this time.
If the economy experiences a rebound and people begin pulling some cash out of savings and putting it back into investments or increasing spending, for example, that could lead to banks increasing their rate offerings.
“I think that is something to hope for,” Tumin says, “even though it’s likely the Fed will hold rates at zero for several years.”