The Cost of Saving

The Cost of Saving

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The books have always told us the ideal macro story regarding how low rates bolster the economy by allowing borrowers to borrow and spend. But what’s the other not so ideal side of the story? If borrowers are the winners in this, then who are the losers?

Let us first start out with the highly glorified story, regarding the monetary policy of low interest rates. Theoretically, low rates make it easier for people to buy homes and cars. This in turn induces demand for other things like furniture, appliances, and car accessories, which really is a chain reaction that should boost a slow economy.

Additionally, the idea is that people will go out and spend more as low rates help them save on interest costs. On a bigger scale, low rates allow companies and businesses to borrow and invest in buildings and equipment among other things. Returns on these investments will then be worth more in the future if rates are higher than those of todays. Investment in businesses will also, hopefully, increase productivity levels and make the economy grow faster.     

Nonetheless, in recent years, low rates have also spurred a refinancing frenzy. Demand for refinancing US mortgages is high due to record low rates. The idea is that when interest rates fall and remain low, homeowners can refinance their fixed rate loans and borrow at a lower cost. However, not everyone is qualified for low rate refinancing due to tight credit standards. In many cases, it can be said that the people who need refinancing most cannot get it, so are low rates really helping those that need to be helped?

The answer is probably yes and no. Yes, as in sure it does allow borrowers to borrow at a lower cost and therefore invest and spur economic activity, which should then theoretically be good for everyone in the country. Another benefactor of low rates, not yet mentioned is our government. By keeping rates low, the government induces people to buy government debt such as treasuries, which makes it a winner.

Moreover, American debt has always been a safe haven for investors. The buying up of American debt by foreign investors have kept rates low to begin with, but the Fed by continuing to buy up government debt has managed to keep rates even lower. The government saves trillions of dollars in interest payments each year by keeping rates low. In fact the recent announcement of a so-called QE3 aims to keep rates low until mid 2015. Yet, rates are kept so low that savers are losing money because bank rates are lower than inflation. Finally, we get to the story of the savers.

Essentially low rates are chipping away savings and forcing those that are planning to live off their savings to retire later. Not only that, many who have retired are re-entering the workforce because they can no longer rely on their savings to sustain the cost of living.  A September 10, 2012 New York Times article noted that Dorothy L. Brooks, 65, who retired 10 years ago has decided to go back to work in a local school, and in her words, “I got hit a couple of years ago pretty badly in the stock market, so now my savings are weighted mostly toward bonds... Now both investments are terrible. And I can’t put my money in a money-market account because that’s crazy. That just pays nothing.” It’s literally as if people are paying the bank to put money in the bank.

In today’s low rate environment where inflation trumps savings rates, some people would rather hold on to their cash than put it in the bank. The same New York Times article also noted that Bill Taren, a retiree in Florida, would rather put cash at home, because then he can at least see the cash when he wants to.

Overall, the winners of this low rate story are the borrowers and the government, as the policy makes it easier for these people to borrow. The losers, nonetheless, are the older people, the retirees, and the savers. In the end, the question is, is the cost of low rates worth it? Does the story of low rates providing a boost to the economy still apply today?

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Select Banks Buck Trend and Increase Their Online Savings and Money Market Rates

Select Banks Buck Trend and Increase Their Online Savings and Money Market Rates

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Several online banks have increased their online savings or money market rates in the last six months. Is this a trend or an anomaly?

Over the past four years, the trends in savings and money market rates have been pretty consistent – down. Week after week we’ve watched banks drop their rates. But in the last several months, a number of banks have reversed that trend and actually increased the rate they pay on their savings and money market accounts.

Among the rate increases we’ve seen are:

  • American Express Bank increased the rate on their savings account from a low of .75% APY in the first quarter of 2012 to 0.90% APY today.
  • ableBanking recently increased their rate from .85% to .90% APY.
  • SallieMae Bank increased the rate they pay on their savings account from .90% to 1.00% APY.
  • In March 2012, EverBank re-started their bonus rate of 1.05% on all new savings and checking accounts for six months. Over the summer they increased the bonus rate to 1.25% for six months.

I reached out to these banks for comment and received a response from Debby Hohler at Sallie Mae, who wrote that: “We continuously evaluate our rates to ensure our FDIC insured savings products are highly competitive, providing value to our customers and a mechanism to fund for our financially responsible private student loans.

To translate, they need the money to fund their student loan business. Deposits have become the most stable, least expensive way to fund a business, and financial institutions that are growing often need more deposits to lend out.

Despite the encouraging rate increases from these banks, don’t expect to see wholesale increases in rates over the next year. Savings rates from local banks and CD rates continue to fall. And while the top online rate in July was 1.25% APY it is now down to 1.05% (a savings account from CIT). We expect the Fed to keep rates at or close to 0% through 2014, if not longer. With job growth anemic, it appears that rate increases are the exception rather than the norm.

As local bank savings rates continue to drop, the online savings rates continue to remain the most competitive option for savers. While local banks often offer more competitive CD rates, especially in longer terms, our data shows that online banks offer the best savings and money market rates. According to the BestCashCow database, only 14 brick-and-mortar banks and credit unions out of over 13,000 beat the best online savings rate.

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How Much of Your Money Should Be in Cash?

How Much of Your Money Should Be in Cash?

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We all know the expression that cash is king. But with rates on savings, checking accounts, and CDs in the low single digits, the question is, how much of a king? How much money should an individual hold in cash?

I spoke with Marc Freedman, President of Freedman Financial in Peabody, MA who said that individuals should "never use their investment account as their emergency fund." In general, he recommends that individuals hold enough money in cash to handle six to nine months of fixed expenses. While it's nice to get interest on your money, he said the main goal of your emergency fund is that it be safe and accessible. For this reason he recommends savings accounts or money market accounts.



Good advice. I personally also like to hold cash if I have an impending big expense. If I am making a major purchase within one to two years, then I'll generally switch the funds to cash to be prudent. We've all heard stories about friends, or friends of friends who planned to buy a home and the down payment evaporated along with the stock market. In this case, a savings or money market account, or a certificate of deposit might be the right fit.

Warren Buffett keeps an enormous amount of cash on hand to be ready and liquid should the right investment opportunities arise. Since Buffett had cash-on-hand, he was able to loan Goldman Sachs and Bank of America money at very advantageous terms. Having cash when others don't can be a big advantage.

Contrarian View of Cash

There are some that argue that cash can even be part of an overall investment portfolio. Marketwatch reported in 2011 about investor Charles Almon advisory service called Growth Stock Outlook. In 1986, Almon moved the bulk of his portfolio to cash and has kept it there ever since. His portfolio is 76% cash and holds just four stocks: Altria Group, Bristol-Myers Squib, Newmont Mining, and Phillip Morris. Despite the fact that he has held mostly cash for one of the largest bull markets in U.S. history, as of September 2011, his portfolio registered an annualized gain of 8.6% versus an annualized gain for the Dow of 8.4%. This is not a truly fair comparison since the Dow annualized gain does not include dividends. But it is still interesting that Almon's cash-rich portfolio came out ahead when just comparing prices.

Two things contributed to this. Great stock selection. Almon's stocks outperformed the overall stock market. And the volatility of the stock market. During the Internet boom and the housing bubble, Almon was well behind. But the stock market fell back to a mean growth level. While there have been some big negative years for the stock market, Almon's cash holdings have never lost money. Instead, they grow and compound every year.

Is this saying that an investor should put all of their money in a 2% 5-year CD? No. But having an emergency fund in cash isn't necessarily the worst investment either.

Building a Cash Fund

Here's how I think about how much cash I should hold. I add:

  1. Emergency Fund: Six to nine months of fixed living expenses.
  2. Major Purchase Fund: Any major purchases I plan to make over the next one to two years (I like to pay out of savings instead of taking on debt via a home equity loan, mortgage refinance, etc.). This could include paying for a wedding, paying for college tuition, putting a down payment on a home, house renovation costs, etc.
  3. Opportunity Fund: A small portion of my investable portfolio that I keep in reserve should a good investment opportunity arise quickly.
  4. Peace of Mind Fund: A portion of my funds that I set aside for peace of mind. The older the investor, the larger this might be. Remember, the purchasing power of this fund may shrink over time if inflation exceeds the savings rate so this peace of mind may comes with a price.

For other opinions and to determine your specific cash allocation, speak to a qualified financial advisor.

No matter what percent you put in cash, make sure to get the best rate on the money in the bank. As Charles Almon showed, by being prudent, a cash investment can still grow. The best bank rates are often 1% higher than the average rates.