They’re just not worth it. They give out a minuscule yield, usually, .10% interest. This is not even one percent. This is one/tenth of one percent!
If you had $10,000 in one of these accounts, it would earn ten bucks in one year. That’s it. Pat yourself in the back, and pocket that $10 into your wallet. Go buy yourself lunch at some fast casual place.
Meanwhile, the bank has your money in this savings account. They will reinvest it into car loans, home loans, HELOC’s, business loans, etc. They will charge higher interest rates.
But, for the sake of argument, let’s say that the bank decides in invest your money into bonds. The bonds usually yield around 2 percent. With YOUR money, the bank earned $200 dollars a year.
Interest Rate Arbitrage
This is how banks earn money and stay in business. They have two interest rate factors; the input interest rate incurred on deposits and the output interest rate earned on loan/bond holdings. The difference in interest rates is profit for the bank.
Why have a bank savings account if you’re funding this interest rate arbitrage at play? Banks are profiting off your savings. Yes, you will not lose money. It is FDIC protected. Day in, day out, you check your bank account, and your money is there.
This is all an illusion. While you fear losing money by stashing it at the bank, you have already lost money to the bankers.
What about HYSA’s?
Enter online-only banks. Bricks and mortar banks are for suckers. People have phones and financial apps now. They can send money to anyone in the world, from anywhere in the world.
These online banks usually have low overhead. Some management. Some compliance guys. Some AML people. Telephone/webchat support. A coding team behind the app/website. Maybe one facility, a co-working space or something. Their expenses should be a lot lower.
In turn, they can offer High-Yield Savings Accounts. As the name implies, they can offer competitive yields similar to bond yields. Usually, they offer 2% teaser rates. The interest rate arbitrage is minuscule. They may make a few pennies per $10,000.
I’m not sure how online banks make money out of HYSA’s. I suspect they gain a lot of volume, signing up depositors with high teaser rates. While pennies are still being made, but multiply that by volume and maybe we’re talking about a nice bundle of Benjamins.
The online banks may branch into brokerage accounts. That means margin borrowing and other exotic financial products. They may offer annuities and insurance. They may engage in consumer, car, and home loans, which widens the interest rate arbitrage and fattens their profits.
Money Market Accounts at Banks
These are reliable accounts. They do have nice yields, too! A person could save money at these accounts and earn bond-like returns. Actually, these funds invest in bond instruments, usually US Treasuries. They do charge a management fee, usually .03 to .04 percent. If a lot of depositors take advantage, the banks makes money off the money market accounts via the management fees.
Bottom Line
By depositing your money into the banking system, you make this money work for other people, i.e. the bankers, brokers, traders, etc. Under this arrangement, your money is fully protected and insured under the FDIC.
That’s not so bad, right? Your money is protected, and bankers make bank on your money. The wheels of finance are turning throughout the world by these activities. Life goes on.
This grand bargain is all but an illusion. There are two factors affecting your savings. Inflation and taxes.
Inflation Erodes Your Savings
The U.S. Department of Labor releases their inflation measurements once per month. Last time I checked, the Consumer Price Index (CPI) was running around 1.8 percent. So, I’m gonna peg inflation at a rate of 2 percent.
Remember that $10,000 deposit in a plain vanilla savings account at the bank? It now has lost $200 in purchasing power by one year! Your $10 dollars in earned interest may only be enough to buy a refreshing beverage.
The same $10,000 deposit at a HYSA bank or money market account will still lose the same $200 dollars in purchasing power. However, the high yield will somehow cancel the inflation rate for these accounts.
With HYSA’s/money market accounts, you’re treading water. You’re not losing money, and maybe that’s all you want out of your savings. You just want your money available and untouched by the markets.
Taxes Are The Final Straw…
Earned interest income is taxed as ordinary income. If you have a job and earn money, it’s much likely you’ll owe taxes on earned interest at your prevailing tax rates. Let’s start with a simple example.
You work at your local burger joint for minimum wage. It is likely that you will not owe any income taxes as the standard deduction for a single filer is $12,000. (For the 2018 tax year.) Under this scenario, any earned interest is unlikely to be taxed.
However, if you earn more than $12,000 in a single year, then your earned interest will be taxed at the 10% rate. This is based on your Modified Adjusted Gross Income (MAGI), which have several factors – deductions, dependents, credits, etc. And yes, the MAGI includes earned interest.
So, that $200 earned in a HYSA/money market account will see a $20 deduction in taxes owed. The tax man cometh, and taketh his share after inflation has already hammereth your savings account!
It’s worse if you’re employed in a middle class job. Your tax bracket could be 12%. If you have a particularly good job, your tax bracket could be at 22% or 24%! (The tax brackets go up to 37%. That is another topic for another day.)
So, with your HYSA/money market account throwing off interest income that are taxable at 10%, 12%, and 22% tax rates, you can see how your savings income and its purchasing power will not keep pace with inflation.
The Alternative
There may be a way out of this savings treadmill that you may find yourself stuck upon. Hopping off this treadmill will involve some risk.
You may need to invest your savings into the stock and bond markets. Yes, your savings principal will be unprotected. It could go down in value, in matter of minutes or hours or days. It could also go up in value in a similar fashion. The markets can be seemingly overvalued and/or irrational.
That is an another article for another time. Putting your savings into the stock and bond markets means putting that money to work for YOU, not the bankers.
Disclaimers
This article is offered for entertainment purposes only. No express or implied warranty of solid, actionable information is offered. This is because personal finance is personal. State and Federal laws vary governing taxtation, etc. Rather, I encourage you to read and gain more financial information from other sources so that you may gain the insight needed to manage your personal finances.
Image Credit by Ken Teegardin – Piggy Bank on Dollar Bills – under Creative Commons license
