Breaking Down High Yield Savings Accounts

Reviewed: July 17, 2014
By FinanceWeb

Demand Is The Key

Bank interest on savings accounts is a phrase with literal truth; the bank’s level of interest in new accounts determines the rate of interest paid. When the banks need more funds to make profits on loans and investments, they will pay more to attract depositors. When banks do not need a heavier flow of cash, they have little reason to offer depositors a larger stake. There are more factors than this simple dynamic in real operation, but there is a kernel of truth in it. Today’s low interest rates reflect the current demand for new or additional deposits. Currently, banks routinely offer loans at 5% or higher, and if they pay depositors about 1%, then there is a substantial opportunity for profit assuming a manageable risk of repayment.

High Yield In Name Only

Today’s typical high yield savings account pays about 1%. In recent eras of greater economic activity and growth, banks routinely paid 4-5%. Those with such memories may wince today when the average is below 1%. Today’s high yield savings accounts do not stand up well to historical comparisons. Time is the primary advantage of a savings account over investments in stocks or a mutual fund based on bonds. Funds in a savings account are liquid, and one can get money when needed immediately without selling a position or complicated withdrawal from investment agreements.

Picking A Place

Choosing a high yield savings account can be as simple as picking the highest interest rates. This is certainly a good a place to start. Additionally, one must examine the terms of deposit and notice whether there are penalties for withdrawals, FDIC insurance, minimum balance requirements, and any hidden charges. High yield savings accounts often provide incentives to add additional accounts such as checking, mortgage services, and auto financing. A few offer higher rates for a limited early period, such as 2% for the initial year of deposit and a lower rate thereafter. One should consider the value of added benefits, if any, and make decisions on that basis. Free checking and enhanced rates for financing can be attractive and beneficial.

There are some emerging hybrids, many new, uninsured investment funds offer the flexibility of deposit accounts and the returns of low-end investment vehicles. Some pay in the range of 3-4% and have low thresholds for participation. They lack FDIC coverage, and do not provide guarantees on yield, rather they provide a prospectus, a record of accomplishment, and information on current performance. Within a range of investment amounts which one can afford to put at some risk, these clubs or investment groups can offer attractive yields.

A Purpose And A Plan

In the current period, high yield savings accounts do not perform nearly as well as investments in the stock market. The S&P index of 500 issuers posted a yield in excess of 6% in 2013, and performed at a slightly higher rate in the first half of 2014. One could assess a loss of opportunity for funds sitting in savings at 1%. However, the bank guarantees the 1% yield, the funds remain available for use, and, unless stated otherwise, there are no restrictions on withdrawal or penalties. There are often specific purposes for monies. A prudent person might set some money aside for instant access and a high yield savings account is perfect for that purpose.

Risks And Terms

One might better invest long-term investment funds in higher yield, fixed-term activities. Higher payouts are particularly important for monies that one intends to use to grow equity or build towards a retirement. However, security is also a vital factor. For example, medium term Treasury Bills pay more than high yield accounts. Ten year notes would pay in the range of 3% contrasted with savings rates of about 1%. While the current stock and bond yields are considerably higher than the 3% Treasury Bill yield, the full faith and credit of the United States guarantees payment on maturity of its notes.

Mutual funds typically operate on annual cycles, however, they lock many preferred investments into 5-7 year terms. Mutual funds yields vary by degrees of risk in the portfolio, however investors should note that many funds have paid far more than high yield savings rates over the past two years. The current period has been quite successful overall for stocks and bonds.