Alternatives to savings accounts
Online savings accounts can be an excellent option if you're looking for a low-risk liquid investment vehicle, but there are alternatives that may provide better terms. If you're planning to open an online savings account, you may also want to consider other options, such as CDs, money market accounts, and high-yield checking accounts.
Certificates of deposit
CDs offer some of the highest interest rates available for deposit accounts insured by the FDIC. They can be a risk-free option if you're investing money you will need for a specific purpose, such as a down payment on a mortgage or a new car, and you don't want to risk losing any of your savings.
How to Compare Online Savings Accounts
The best online savings accounts offer high APYs, no fees, and low minimum balance requirements.
When you're looking at online savings accounts there are three factors that you should consider closely.
The first is the interest rate. Make sure you choose a bank that will pay a solid rate of interest on your deposits.
Next, look at the fees. Some banks charge monthly maintenance fees. These fees eat into your account balance each month. Choose accounts that either don't charge a fee or allow you to avoid them by keeping a minimum balance or setting up automatic deposits.
Finally, think about how easy it will be to access your cash. One of the reasons to keep money in a savings account is so that you can access it quickly in an emergency.
What's the difference between interest rate and annual percentage yield (APY)?
When you look at savings accounts, you'll often hear the terms interest rate and annual percentage yield or APY.
The interest rate for a savings account measures the amount of interest the account pays without accounting for things like compounding. The APY of an online savings account reflects the true amount that you'll earn over the course of a year based on compounding.
Consider this example. You put $10,000 in a savings account that pays 1% interest, with compounding once per year. At the end of the year, you'll have $10,100 in the account. Both the interest rate and the APY are 1%.
If the interest compounded monthly, at the end of the year, you'd have $10,100.46 in the account instead. The interest rate is still 1%, but the APY is slightly higher at 1.004596%.
If interest compounded daily, you'd end the year with $10,100.50, making the APY 1.005%
In general, interest rates are lower than APYs, so banks will advertise the APY of their savings accounts because the number is larger and more appealing.
What affects the interest rate of high-yield savings accounts?
Interest rates are complex and change all the time. Banks can change the interest rate of their savings accounts at any time, so it's important to understand how banks decide how much interest to pay on your savings account.
The interest paid on any savings accounts, from high yield, online savings accounts to brick and mortar savings accounts, closely follows the Federal Funds Rate. The Federal Funds Rate is a benchmark interest used by the Federal Reserve to direct the economy.
When the Fed wants to encourage spending, it often lowers the Federal Funds Rate. This, in turn, makes loans cheaper and reduces the interest rate on savings accounts. That makes people more willing to spend money. However, this can cause inflation.
When the economy is strong or inflation rises, the Fed may raise the Federal Funds Rate. Loans become more expensive, and savings account interest rates rise, discouraging spending and encouraging more saving.
As the Federal Reserve changes the Federal Funds Rate, banks adjust the interest rates for their savings accounts, which impacts the amount that you earn on your deposit. Even the best high yield savings accounts may have to decrease their annual percentage yield if the Fed drops the rate.
Can you lose money in an online savings account?
High-yield online savings accounts, like traditional bank accounts, receive federal deposit insurance from the FDIC. This insurance protects people who deposit their money in bank accounts, whether they're checking accounts
, savings accounts, money market accounts, or CDs. This applies to brick-and-mortar or online banks. Credit union customers get similar protection from the NCUA.
The insurance covers up to $250,000 per depositor at FDIC-insured banks. If you have less than $250,000 across your checking account and savings account, you cannot lose that money. If the bank cannot return your funds, the FDIC will step in to reimburse you for the amount lost.
The primary way to lose money in a high yield savings account is through monthly fees. Some banks charge a monthly fee, often called a monthly maintenance fee. To avoid these charges, you have to meet minimum balance requirements or jump through some hoops, such as depositing a minimum amount every month.
When to use an online savings account
While your checking account holds money that you need available to spend, savings accounts are designed to keep money you don't need on a day-to-day basis.
Savings accounts don't offer many of the convenience features of checking accounts, like an ATM card or a checkbook. If you want to spend money from your savings account, you usually have to transfer it to a checking account first. In exchange, savings accounts pay more interest than checking accounts, which often don't pay any interest.
Typically, the annual percentage yield on a savings account isn't enough to beat inflation, so you're still losing some spending power by keeping money in your savings account.
One of the best uses for an online savings account is to store your emergency fund or hold your money while you look for a better investment during a market downturn. The main advantage is your money safe and you have immediate access to it.
The best online savings accounts offer higher interest rates than brick-and-mortar banks. High yield savings accounts can pay rates that are ten times higher or more. The higher interest rate means you won't lose as much spending power to inflation and you will have more financial resources available if you run into an emergency.
Where can I get 5% interest on my money?
These days, it's hard to find a savings account that pays 5% interest. Most accounts, even high yield savings accounts, pay a lower rate.
Your best bet to earn 5% interest on your money is to look for financial institutions offering special promotions. Sometimes, you'll find an app or a bank giving customers 5% interest on a small balance, such as $1,000. Or you may need to meet certain requirements to qualify, making it even harder to earn 5%.
The list of accounts above includes some of the online savings accounts with the highest interest rates. Another option worth considering is opening a high-yield checking account
, which can offer APYs of (or close to) 5%.
What is the best online savings account available right now?
There is no one answer to which savings account is the best right now. Each has pros and cons, and the answer will change as your needs change, and banks compete, adjusting their offerings. The online savings accounts listed above are a good place to start your search.
To find the best savings account, look at three things.
- First, how much interest will you earn? The higher the interest rate, the better.
- Second, what fees does the bank charge? Are there monthly maintenance fees, and if so, how hard is it to avoid them? Maintaining a minimum balance or making a set number of transactions to avoid fees can be a hassle. The last thing you want is to pay a bank for giving it the privilege of holding your money.
- Finally, how easy is it to access your cash. You want a savings account that you can access relatively quickly. If it will take a week to get to your money, or there's a strict limit on withdrawals, you should look for another bank.
Pros and cons of online savings accounts
Before you open an online savings account, you should think about these pros and cons.