Friends Don't Let Friends Earn Zero Interest (On Their Cash)

Welcome to Saving Money with Andrew!

From late 2008 until 2022, we lived in an almost zero-interest rate world. Bank accounts paid zero, new mortgages were well below 5% (sometimes much lower), and car loans with low interest rates or 0% promotional financing were plentiful. Many of us have lived our adult lives earning zero interest on our cash.

The world has changed. In just a year, the Federal Reserve has raised the “Fed Funds Rate” (the rate that banks charge each other to borrow money) from approximately zero to around 4.5%.

You’d think with higher rates, banks would raise rates on checking and savings accounts. Nope! Last month, I found out that my checking account was still paying 0.01%, and my savings account an almost-as-embarrassing 0.25%. This is typical—the banks simply kept rates near zero and hoped we wouldn’t notice.

There are many reasons to hold a substantial amount of cash in savings. Everyone should have an emergency fund, and many people are holding extra cash in anticipation of paying a tax bill in April.

But earning zero (or almost zero) on that money is an absolute waste. If you keep an average of $10,000 in cash in your checking earning 0%, you are losing at least $400/year of interest at current rates. If you have more in savings, the numbers could be far higher.

Fortunately, there are a couple of competitive options, albeit with small pros and cons:

Bank CDs

For many years bank Certificates of Deposit (CDs), in which you’d leave your money for a pre-determined period, made little sense. Rates were little higher than zero, and if you needed your money before the maturity of the CD, you’d have to pay an interest penalty.

But unlike checking/savings, banks have aggressively increased CD rates. Recently, I opened a short-term CD to hold money I needed to pay taxes in April. The bank was willing to pay a 4.3% annualized yield for a three-month CD, and required almost no paperwork to open the account (the CD is just another line on my existing bank statement below my checking account). I don’t need the money until Tax Day, but even if I did, the early withdrawal penalty would be no more than the amount of interest earned.

Check with your bank about their short-term CD options. And if they’re not offering a competitive rate, shop around. For example, I recently came across a Capital One offer for a 5% 11-month CD (I have no existing relationship with Capital One or any accounts with them), valid until 3/14/2023.

Pros: Easy to do, still covered by FDIC insurance (up to the $250,000 cap)

Cons: Interest penalty for early withdrawal, rates may be slightly lower than other options.

Low-Fee Money Market Funds

If you need access to your money at any time, a money market fund may be a good option. Money market funds invest their money in highly-liquid, low-risk instruments (e.g., short-term US government bonds) meant to maintain the value of your investment. These funds typically pay competitive interest (e.g., at the time of this post, the Vanguard Federal Money Market Fund yielded 4.5%) and can be sold at any time. Make sure your fund has a very low expense ratio—the Vanguard fund has an 0.11% expense ratio. I wouldn’t consider anything with an expense ratio higher than 0.25%.

Unlike bank accounts or CDs, money-market funds are not FDIC-insured. These funds are not zero risk, but in practice losses are extremely rare. This Wikipedia article offers a nuanced and seemingly-balanced discussion.

Pros: Liquidity whenever you need it

Cons: No FDIC insurance, extremely small (but non-zero) risk

Finally, while you’re at it, make sure that your cash in your brokerage/investment account is earning competitive interest as well. The default “cash sweep” options for many brokerages are still well below 1%. I wrote about this issue in Don't Let Your Cash Get "Swept" Away, and in this new world of 4-5% interest rates, low rates on your savings should be a thing of the past.

And finally, as always, this newsletter is *not* intended as investment advice.

And now, Andrew’s pick(s) of the week:

He Turned Wall Street Offices Into Homes. Now He Vows to Remake New York - Good discussion of the challenges of converting NYC office space to apartments, with some interesting examples.

How Much More Tax-Wise Are ETFs vs. Mutual Funds? - I always knew ETFs were generally more tax-efficient than mutual funds with similar holdings, but had no idea the difference was this large.

And Planet Money delves into what they call “The Ice Cream Conspiracy” (podcast), with some fascinating findings.

I hope this has been helpful. If you liked it, please share it on social media! Also, please send me your feedback, requests, and success stories.