Where Should You Squirrel-Away Your Cash?

Savings rate is up

Thanks to the government’s giant stimulus program, many Americans seem to be feeling a little better about their finances. Despite rising unemployment, personal incomes still rose 1.6 percent in May, according to the Commerce Department. But instead of heading back to the mall with that extra cash most Americans are making a beeline for the bank.

The U.S. savings rate recently reached 7 percent of disposable income – the highest it’s been since early 1990s. In the short term, such penny-pinching could delay economic recovery by suppressing demand. But in the long run it’s a good thing. It means families are working to reduce high debt levels, rebuild retirement accounts, and be better prepared for financial emergencies without resorting to unsecured personal loans.

Interest rates are down

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Unfortunately, interest rates on most savings products are currently very low. Interest on savings accounts typically tracks the Federal Reserve’s funds rate, and right now that’s hovering between zero and 0.25 percent—its lowest level ever. One-year bank CDs are a slightly better option, recently yielding about 2 percent on average. Think twice, though, before committing to any period longer than that. “Short maturities give you the ability to reinvest so you can continue to stay ahead of inflation once rates and inflation perk up,” says Bankrate.com’s Greg McBride.

Treasury Inflation-Protected Securities are an attractive option over the longer term. Uncle Sam pays a fixed rate – recently 1.25 percent – plus an “inflation kicker.” If consumer prices go up, your principal will be supplemented.

Slightly higher online

A few banks are paying decent interest on checking and savings accounts, but you have to play detective to find them. Many smaller banks offer “rewards” checking accounts yielding 4 percent or higher in order to attract customers. But as Daren Fonda said in SmartMoney:

Does that make them a good deal? That depends. You can usually find a slightly better rate online, especially at one of the Internet-only banks that don’t have to pay tellers or other branch expenses and can pass on the savings. But the gap has narrowed as Internet banks have started to focus more on profitability than growth. “We’re getting as much money as we need,” says James Kelly, chief operating officer of ING Direct, the largest online-only bank, explaining why ING’s rates aren’t higher. Indeed, ING is now trying to get customers to branch out from basic savings to other services such as checking accounts and mortgages.

There’s only so much banking you can do with the click of a mouse, though. Most online-only banks have limited services, so you have to go elsewhere for extras like lines of credit or auto loans. Firms like ING Direct and Discover Bank don’t have their own ATMs, and customers may be charged fees if they want to withdraw cash from another bank’s ATM. Cashing a check can also be a hassle with a branchless bank. Customers either have to go through a traditional bank or mail in the check.