Occam's Razor

Well here’s something I didn’t think we’d be doing again: chasing higher interest rates.

For the last ten years, savings account interest rates have been hovering around zero percent. This was by design after the Great Recession. The Fed wanted to stimulate the economy. The natural tendency of Americans in a recession is to run toward safety. Savings accounts offer that if you have enough money in them to live on. But that’s all they offered. They were not investment opportunities. By cutting interest rates to basically nothing, the Fed was encouraging us to invest in the market. And it worked, although it took a long time.

It is only now a decade later that the Fed is raising interest rates again. Still, most banks are stuck in 2009 and offer virtually no interest on their accounts. But there are others that have gotten with the times, including our bank, Ally Bank. Their savings account now offers 2% annual return regardless of its size. It’s not quite enough to meet inflation, but it’s better than 0.1%. Their money market account is less generous: .9% on balances below $25,000 and 1% on balances above it. Its 12-month Certificate of Deposit though will earn you 2.65% annually. A five-year CD earns 3.1% annually. Ally Bank is an online-only bank, which in part explains their ability to offer these rates. With no brick and mortar buildings to maintain except one headquarters building in Philadelphia, their operational costs are low.

Nonetheless, old habits die hard. I am so used to getting virtually no interest that I’ve maintained our checking account where it’s been for nearly thirty years: Pentagon Federal Credit Union. I still haven’t severed my relationship with PenFed, but the time may be coming. However, I have moved the bulk of our money in PenFed to Ally where it at least earns a good interest rate.

Traditionally we’ve dumped paychecks into a checking account. That’s because most of it was gone by the end of the month, so interest on the account was kind of pointless. Now that we are retired though, it makes no sense. The house is paid off. We have zero debts. What makes sense now is to take our income, mostly pension income, but also 401K and other income from teaching and consulting and stuff it into savings accounts, where the balance earns 2%. Now we have a monthly automatic transfer from our savings account to our checking account based on how much we are likely to spend in a given month. This way most of this money earns interest. This monthly automatic transfer into checking mainly involves figuring how much we will spend monthly on the general cost of living. The idea is to keep our checking account balance low, but not so low as we are likely to overdraw it.

I’ve done this with our Money Market account too. Even at Ally, it was only earning 1%. The account exists basically as long-term savings, but it was really an escrow account. It holds funds that we are accumulating to pay for future long-term expenses, stuff like buying a new car or replacing the roof in fifteen years. But there was no point in taking the hit on interest. So we’ve reduced the balance there to $5,000 and moved the rest into savings. I figure $5000 is the most we are likely to ever write from the account quickly. If we need to write a check for more than that, there will be time to move it from savings.

Oddly enough, this approach is amounting to real money, to the point where when I estimate our income for the year it’s becoming a not insignificant portion of our income. With 2% interest, it amounts to more than $150 per month in interest. Do the math and we should net at least $1800 annual income just from interest, most of it from savings. Granted that our cash reserves are now flush where they weren’t ten years ago. But by simply rethinking how we are managing our money, we’re bringing in this extra money every year, with zero risk to our portfolio. The only real risk is that the Fed will drop interest rates again, which certainly could happen. Markets are definitely in correction territory, suggesting that if things go awry again like in 2008, zero interest rates and more “quantitative easing” may be in the future.

So this is good for us, but not so good for the rest of you who I assume are borrowing a lot of money. It’s pushing up interest rates in general, but home mortgage interest rates in particular. For ten years the economy has been propped up by super cheap interest rates. That’s changing, which will put more stress on borrowers, perhaps adding to our risk of recession.

Still, these higher interest rates are notable. Savings accounts pay real money again, at least if you are using the right bank. It should reshape thinking in the way things are normally done. It has certainly reshaped our thinking. It’s always good to keep a healthy amount of your assets in safe forms like savings accounts. It’s just that now it is beginning to pay to do so again.