Why Do Savings Account Interest Rates Go So Low?
Low interest rates on savings accounts are not new — this trend has been in effect for years. However, investors care less about savings rates when inflation isn’t an issue. And in a poor economy, people accept low rates because their main objective is to avoid losing money.
Today, though, the economy is heating up. Prices are rising faster than they have in decades — and after savings account rates lagged for awhile, they are starting to catch up. But why were they so low in the first place? And can it happen again?
Why Do Savings Interest Rates Go So Low?
There are a few reasons why interest rates on savings accounts go so low. The Fed, investors, and banks contribute to this phenomenon, just like they do when rates go up.
Banks Don’t Need Deposits
During COVID lockdowns, Americans saved more and borrowed less. At the time, banks had more money on deposit than they could lend, and every dollar that they weren’t lending was eating into their profits.
The only way to protect their bottom line when people aren’t borrowing is to pay less interest on savings accounts. Until institutions need more deposits to keep up with the demand for loans, they have no incentive to increase that they pay depositors.
This will happen only when enough people move their savings to other investments or more people apply for loans.
The Fed Believes That Inflation Is Temporary
Yes, prices are up, but many believe that recent inflation is mainly the result of temporary supply chain issues and labor problems.
Federal Reserve Bank Chair Jerome Powell recently testified before the House of Representatives that the Fed would not respond to short-term price spikes by raising interest rates and risk weakening the economic recovery.
“By inflation,” he explained, “we mean year after year after year prices go up. If something is a one-time price increase… you wouldn’t react to something that is likely to go away.”
“We really do believe,” he added, “that these things will come down of their own accord.”
In the U.S., high-yield savings APYs (annual percentage yields) are tied to the federal funds rate set by the Federal Reserve. As long as that rate remains low, deposit rates are unlikely to budge.
Investors Want Safe Havens
Investors overseas and at home are still pouring money into US Treasuries. As long as the global economy is shaky, people and institutions care less about returns on their investment and more about not losing their principal. Demand for safe places to park money keeps U.S. interest rates low.
Which Banks Have the Best Savings Account Rates?
Finding the bank with the best savings account to meet your needs is as simple as using our search tool. Compare savings accounts and find the best rates being offered today.
When Do Savings Account Rates Go Up?
Banks will not pay higher interest rates for savings deposits until they have to. When savings interest rates are unacceptably low for savers, money eventually flows out of banks and into the stock market and other investments like real estate. And low interest rates and economic recovery tend to spur borrowing.
Eventually, the demand for loans rises, while the supply of deposits dries up — until banks need to attract more deposits to meet the demand for loans. That is when they will increase the interest rates they offer savers.
The other factor that may cause banks to increase what they pay for deposits is the Federal Funds Rate, which the Federal Reserve controls.
How to Deal With Low Savings Interest Rates
Depending on your comfort with risk, you can use several strategies to ride out this period of bargain-basement interest rates. Here are a few possibilities.
Shop for Better Savings Accounts
Even the best savings account rates are lower than they used to be. But you may be able to improve your interest rate by using some wise strategies to find the best savings account rates. For instance, online banks often offer better rates than brick-and-mortar institutions.
Do some comparison shopping and switch banks if necessary. But keep your perspective — while a 0.2% APY is twice as high as a 0.1% yield, the difference is still only 0.1%. You might be better off comparing factors like fees, the convenience of branches, and the availability of ATMs.
Suck It Up and Wait
If you have a million dollars earning just 0.25% while prices increase by 5% a year, you’ll lose substantial wealth. If you only leave $25,000 in savings and move the rest into better-performing vehicles, you can minimize the damage.
Avoid tying up excess amounts in investments paying near-zero rates. Even tried-and-true strategies like laddering CDs won’t help much, as average rates for five-year CDs are currently less than 0.5%.
The good news is that either the Fed will adjust its inflation expectations and raise rates, or public demand for loans will eventually force banks to boost yields and attract deposits. Or inflation will retreat and we’ll stop caring about low deposit interest rates.
Keep an eye out and periodically compare savings rates until it’s worth moving money back into high-yield accounts and CDs.
One way of increasing your potential return is to increase the amount of risk you’re willing to accept. It’s important, however, to stay in your comfort zone and consider your financial position.
If you have many years until retirement, you are in a better position to ride out market downturns than you are if you’re already retired. You can probably take a few more chances with some of your holdings. However, you must consider your temperament — it’s not worth jumping into better-paying investments if you’re miserable and sleepless from worrying about them.
If you decide that you do want to broaden your investments, determine how much of your savings you’re likely to need in the next few years and lodge that in an insured, high yield account. You never want to gamble with emergency savings or money you’ll live on in the near term.
Alternative Investments for Savers
No investment is risk-free. Even your high-yield savings. That’s because even if you retain your principal, you lose money every year that the inflation rate exceeds your account’s APY. Here are some investments that tend to do well when the economy heats up.
Stocks, Mutual Funds, ETFs
Stocks have a great track record for beating inflation. Over the last 50 years, the average return for the US stock market is just under 11%. However, you do risk losses in the short term. Minimize that risk by diversifying across different sectors (food, energy, and household goods perform well) with highly-rated mutual funds or exchange traded funds (ETFs).
You can hedge against inflation with precious metals or commodities like oil and farm products. It’s not necessary to trade on the commodities markets — you can purchase shares in mining or energy stocks or in commodity-based funds.
Treasury Inflation-Protected Securities (TIPS) prices move with the Consumer Price Index, which makes them a good hedge against inflation. Risk is very low because they are backed by the U.S. government.
Real estate is another asset that performs well against inflation. One benefit of today’s low interest rates is the opportunity to borrow cheaply with mortgages.
Rental property does well because rents tend to rise with inflation, while the rate and payment for a fixed-rate mortgage does not. If managing property doesn’t appeal to you, consider tax-advantaged real estate investment trusts (REITs).
Don’t Worry Too Much
Any mismatch between a current inflation rate and average savings APY is probably temporary. Either the Fed is right and inflation will correct itself in a year or two, or banks will raise rates.
Your mission until that happens is to move money you won’t need to access for several years into better-paying investments (as long as you can deal with some risk). And to shop for the best account for the money you do leave in savings.
About the Author
Gina Freeman writes about personal finance and has been featured on MoneyRates, The Mortgage Reports, MSNMoney, Fox Business, Forbes, The Motley Fool, and other fine websites. Her background includes tax accounting with Deloitte, over 20 years in mortgage sales and underwriting, systems consulting for Experian, and several years in bankruptcy law. Gina enjoys helping consumers make confident and intelligent financial decisions.