Savings accounts growing in popularity as investments amid higher interest rates
Zachary Halaschak
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For more than a decade after the Great Recession, savings accounts fell out of favor as investment tools due to low annual returns. But amid the Federal Reserve’s historic tightening cycle, part of its efforts to crush inflation spurred by the COVID-19 pandemic and other causes, bank savings accounts are increasingly profitable.
For years, parking money in a savings account seemed wasteful, given annual percentage rates could only be locked in at sub-1% levels. Other investment strategies proved more lucrative, if riskier. But as the Fed pushes its interest rate target to the highest level since the turn of the century, annual percentage rates have surged, making them a more viable option.
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Not that bank savings accounts are ever likely to be the driving tool of an investment strategy. Investment industry professors say there are still plenty of other safe ways to make higher returns than in a savings account or fixed-term certificate of deposit alone.
Still, many who had written off savings accounts as investment tools in years past are now giving them a second look, even if they still don’t produce the best yields.
“Oh my gosh, it’s night and day,” Jamie Cox, managing partner for Harris Financial Group, in Richmond, Virginia, said of the change in savings account yields from just a year or two ago. “If you think about how much people are making in savings accounts now versus what they were two years ago, it’s 300% at a minimum and more like 400% on average.”
For example, Evergreen Bank is offering savings account rates of up to 5.25%. So, if someone were to invest $25,000 with that return, they would be earning just over $1,312 in interest in just a year alone. Compounded over a decade, there would be some $16,700 in interest, and that $25,000 investment would have grown to $41,700.
Compare that to when rates were lower and an account was only offering 0.4% interest. If someone invested that same $25,000, they would only earn a measly $100 after letting it sit for a year. Compounded over 10 years, that initial investment would have only grown to $26,000.
Cox noted that holders of savings accounts and CDs might be in for a surprise come Tax Day. He said that because of the excess interest that people are earning, there are going to be a lot of high savings deposit interest earners who are going to be asking their accountants why they suddenly owe much more in taxes.
Banks have been slow to offer higher rates for savings accounts to their customers, even despite the Fed’s rapid hiking over the past year or so, according to Cox. He said that is because money is so plentiful that the banks are “literally choking on deposits” and thus don’t need to pay up for money.
“So, most banks have been slow, at some cases at the pace of a glacier slow,” he told the Washington Examiner.
While savings accounts have certainly become more profitable than just a year ago, Cox said he is still advising people to invest their money in Treasury bills or money market accounts. Both are still very safe options with little risk and higher rewards, he said.
“The savings accounts, they’re getting better but they are still way lower than some of the other short-term interest-bearing options that consumers have access to,” Cox said, noting that he pulls money out of savings accounts all of the time and invests them in T-bills.
“The reason I do is because Treasury bills have rates that exceed 5%, and not only do you get the higher interest rate than a savings account, you don’t have to pay state income taxes,” he continued. “So, if you live in a high-cost state like New York, or Maryland, or New Jersey, or one of those, you get higher rates, and you get lower taxes.”
Thomas Mathews, a finance professor at Florida Gulf Coast University, told the Washington Examiner that while savings rates and CD rates have risen, and relatively quickly given the Fed’s action over the past several months, there are still other investment vehicles that consumers should find more attractive. He noted Treasury bills in particular.
Savings accounts are safe stores of money because the Federal Deposit Insurance Corporation insures all deposits of up to $250,000, although Mathews pointed out that T-bills are also a safe bet for investors.
“When you place your money in T-bills, you have the full faith and credit of the U.S. government behind it, so you know that you’re going to get your money back and you’re also going to get your interest back,” he said. “There is no instrument as safe as Treasury bills, and in fact, T-bills are paying rates that are even higher than some savings and CDs.”
But will the yields on savings accounts go higher, or have they reached their zenith? A lot of that is going to depend on what the Fed does next. The Fed’s last rate increase was at its last meeting in July, driving interest rates up by another quarter of a percentage point. All eyes are now turning to what the Federal Open Market Committee will decide at its next meeting later this month.
Inflation has meaningfully fallen since the start of the year, with the consumer price index punching in at just over 3% — still above the Fed’s 2% target but well below the explosive 9% levels it was hitting last summer. And the markets are predicting a pause.
Investors’ insights can be gleaned through the CME Group’s FedWatch tool, which calculates the probability of where rates will be down the road using futures contract prices for rates in the short-term market targeted by the Fed.
An overwhelming majority, 93%, of investors think the Fed will pause at its next meeting in September. But from there, it gets a little more mixed. About 46% of investors think that rates will be higher than today after the Fed’s November meeting, and just over 40% think rates will be higher than now as we enter 2024, with 3.5% even betting that the Fed will have cut rates by then.
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Mathews, though, in addition to other economists, is leaving the door open to more Fed tightening, meaning that interest rates could push even higher by year’s end, although they do appear to be near their cap.
“It looks like it’s getting toppish. By that, I mean it looks like it’s getting to the end of its road,” he said.