Why I Don't Care If Your Online Savings Account Pays 3.4%, 4.4% or 5.05%

I'll start this out with a quick primer:

There are 3 and only 3 things you can do with money.

  1. GIVE
  2. SAVE
  3. SPEND

Anything you do with money is going to fall into one of those 3 categories. Everything. Under the SAVE category, there is short-term savings (0-5 years), and long-term savings (5-10+ years).

  • Short-term usually takes the form of a savings account, CD, or money-market account and is commonly referred to as 'Savings'. These need not be big earners, since with higher returns come higher risk. This is money that has an earmark, has a purpose and you are planning to spend in one way or another. This money needs to be there. Your emergency fund would reside in 'Savings'. The whole point of an emergency fund is a hedge against the everyday risks of life. You don't want to look up one day and find half of it gone because a couple of your stocks tanked - they have a tendency to do that the week before you get laid-off. Savings is not a big earner, but its nice if it keeps up with taxes and inflation (commonly ~4%).

  • Long-term usually takes the form of mutual funds, stocks, bonds, real estate, 401k's, 403b's, IRAs.... and is commonly referred to as 'Investing'. A CD or on-line savings account are poor excuses for investing. If your investment is not turning out 10-12%+ long-term, then it's not much of an investment. When picking mutual funds, they'll typically show you the 1-yr, 5-yr, and 10-yr averages. Some, if applicable, will show average returns since inception(I have some great ones that are ~40 years old). Buying a fund less than 10-years old makes me nervous and here's why: the year 2000, and the dot-com bust. If your fund of choice survived that and even turned out a profit then you may have found a good one. You'll want a fund that can weather a storm and provide solid growth in the long-term.

Now here is what makes me sick. These jokers who think they are 'financially sophisticated' because they spend their time shopping interest rates for on-line, high-yield savings accounts. They typically go about this process after the Fed cuts the interest rate and some hype comes out about "ING Cuts Interest Rate for On-line Savings From 4.1% to 3.40%!!!". Doom and gloom! Who would have thought that savings accounts were tied to the Federal Funds interest rate?!? "Oooohhh! HSBC is paying 5.05%! Must. Move. Money!" Then two days later comes the, "HSBC cut their rate too! And just after I moved all of my money to them." sob story. This also happens when rates go up and everybody scrambles for that new great rate. This is crazy behavior. Here's why.

Lets say, for example, you have a $6000 emergency fund in a high-yield, on-line savings account paying 4.10%. Yea, rah. Over the course of 1 year, assuming no change in balance other than the monthly interest, your $6k would have turned into $6250.68. Now what if the Fed had cut the interest rate at the beginning of that year and your account of choice were paying 3.40%. Your $6k would have turned into $6207.21. A difference* of $43.47 over the course of one year with all the same assumptions. We should all be so lucky to have no emergencies in a year. Anyways, $43 difference* to jump through all the hoops of setting up a new account and transferring everything from the old one?

From a personal standpoint: Its probably not worth your time. Go spend time with your family and get away from the computer. Do something productive. Not good enough? Read on.

From a financial standpoint, lets look at the math, since so many think its all about math (BTW: Its not all about math, but I'll do it anyways):

Lets assume the gains of the 4.10% example as $250.68. The reason for the asterisks above is because those numbers are not adjusted for taxes and inflation. Important stuff. Average inflation for 2007 came out as 2.85% - a three year low! Still, once adjusted for inflation, your $6250.68 now looks more like $6,072.54 - A difference of $178.14! But the government doesn't care. All they see are the gains of $250.68. Assuming a 25% tax bracket, Uncle Sam is going to lighten your pockets by $62.67. That brings the damage of taxes and inflation to $240.81, giving you an effective net gain of $9.86, meaning that taxes and inflation hit most of us at 3.84% for 2007. And you laughed at my 4% estimate! (C'mon admit it.)

So I don't care what your "high-yield", fancy-pants, on-line savings account yields. So long as its near 4%, its not worth getting excited about. Am I down on these accounts? No way. We have one and we're very pleased with it. Its much better to get the tax and inflation hedge of these accounts rather than effectively losing money in a traditional savings account (what are they paying these days? 0.25%? 0.35%?). Do we move it to higher paying accounts as often as Mitt Romney changes his campaign slogan? No way. How about as often as he changes his stance on major political issues? Still no. In fact, since the inception of the account, we've moved our cash for the purpose of getting higher returns exactly zero times. We've taken money out, and put money in, but never moved it to a competitor. There is just no reason to do this- personally or financially. This is similar to buying technology - do your homework, pick the one that works for you, and go on down the road. There is no point to stewing and fretting about this minutia. We're talking about fractions of a percent here! Unless you have big big buck in one of these, the difference won't amount to a hill of beans.

Some talking points: Have you ever done this savings account shuffling? Is there some advantage that I'm missing? Were you already discounting your returns for taxes and inflation? Think my math is wrong? Hit us up in the comments.

Full Disclosure: We have part of our emergency fund in an on-line account (just so that we are losing less to taxes and inflation) and part in a local, brick-and-mortar savings account (just for easy access).


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