After talking with my bank about interest rates and other available options, they reminded me of some information I think is interesting. Why have interest rates been on a declining path?

Several years ago we opened new checking and saving accounts with First Merit Bank, headquartered in Akron, OH. Their product was called Reality Checking and Reality Savings. Basically, they were no fee accounts, with no or little account minimums, free checks, and very little hassle. The best part was the interest rate on the saving accounts was way above what was being offered at other brick and mortar banks.

If I remember right, the interest rates started out in the 2-3% range several years ago, and quickly dropped to their current rate of less than 0.75%. Grant it the rates are better than a lot of other current offers, but still pitiful none the less. The bank reminded me that they can get money from the government right now for around 0%. On top of it, banks are not lending out as much as they used to in the past, especially First Merit, who is among the stricter. Therefore, banks are sitting on large stockpiles of cash, and as a result, do not need our money and can afford to pay us very little interest.

Until the government starts raising interest rates and making it more expensive for banks to get money, they will have no need for our cash and can keep paying interest rates low in return.

So what are your options?
Certificates of Deposit (CDs) – These accounts really vary from bank to bank. In most instances, CD rates are next to zero percent unless you are willing to lock your money in for 5 years or longer. In addition, should you need your cash, you will pay a hefty fee of so many months of interest as specified by the institution.

The majority of our savings needs to be liquid since we are looking to purchase a new home in the near future. In addition, I never like the idea of being locked into an account where the market is constantly fluctuating, and we could be making more money possibly elsewhere.

Money Markets – Back when I first started getting smart financially, money market (MM) accounts used to be the way to go to maximize returns. I opened my first MM back around 2001, at the now defunct NetBank. I held my funds in their MM account and earned good interest for the time above and beyond what was being offered elsewhere. There was a slightly higher risk associated with MM than a Savings or CD account, but the payoff was considerably more. In today’s market, I have not seen valuable returns on MM accounts.

Investing in Mutual Funds, etc. – This option is definitely among the riskiest of all options, and in today’s volatile market, has considerable risks to consider. The first being how risk tolerant are you? If you are not comfortable with possibly losing some or all of your money over the short term, run the other way now.

Money you have in a savings type account are not necessarily like retirement funds. Retirement accounts are meant for long term growth, assuming you are not close to retirement. Therefore, the account will gain or lose value day to day, but historically the funds should have positive growth over long periods of time. Money in savings type accounts though are meant for short term goals, in general, like an emergency fund or some other goal (purchasing a home, fixing a broken appliance, etc.). Therefore, if you need access to the funds, the money would be subject to the market conditions at the time, which could include a substantial loss or gains.

In addition, you need to look at the possible time frame for holding onto the funds. If we were to put some of our money in a mutual fund right now, and then need the money for purchasing a home in say 3 months, we would be subject to short term gains on any growth in the fund. Depending on your tax bracket, the taxation portion could be substantially more than if you had held the funds for greater than one year.

Interest Paying Checking Accounts – There are lots of checking account products currently promoting interest rates in the 3-4% range. The catch is that you need to have so many debit card transactions per month (typically 10 or more), have automatic deposits, and do all of your banking online. All of these items are doable; however, we have chosen not to go this route yet because the purpose of our savings is to not spend it. Putting our money in this type of account puts us at risk of accessing the money a lot simpler than if it was in a savings account without a direct debit card access. Keep in mind, these accounts also drop the rate down considerably if you do not meet the requirements of the account.

This is not meant to be a comprehensive list of all the options available, and only highlights some of the more popular alternatives.

Therefore, the best options for us, considering our money needs to remain liquid over the short term, is to keep the money in the savings accounts.