High-Yield Savings Accounts

Today's topic is high yield savings accounts. A high yield savings account is exactly what it sounds like. It is a savings account at a bank or a brokerage that offers a higher interest rate on your cash than a savings account at your average local or national bank. When I graduated dental school and knew nothing about personal finance, I had our checking and savings account at Chase bank because they were everywhere and I got some kind of bonus to sign up with them. As I started building my emergency fund in my savings account like Jim told me to, I noticed one year I got a statement from Chase showing I made $1.09 in interest during the year. A closer examination of the statement showed the savings account paid an interest rate of 0.02%. 2/100 of a percent. This is your classic low yield savings account that the vast majority of Americans are using, presuming they even have a savings account at all. Today we are here to make sure you don't fall victim to this unfortunate hole in our financial literacy. We want you to be earning a reasonable rate on your cash. To do that, don't let your cash sit in a savings account at the local credit union or some enormous national bank paying you no interest. Make sure you're keeping your cash in a high yield savings account. To find a good high yield savings account, you can always Google it and a list of banks will come up. Some common ones I see clients use are Ally Bank, Sofi, Wealthfront, Capital One, Discover, Marcus, there's others. What makes for a good high yield savings account? Well, the first and most important quality is a reasonable interest rate. Right now in late September 2024, that means 4 to 5%. Don't worry too much about finding the highest rate. The difference between 4.2 and 4.9 is not what we are worried about. What we're worried about is the difference between 0.02% and 4.5%. Just to drive that point home, let me quantify why you don't need to stress about getting the best interest rate. Let's say we're talking about where to keep your $60,000 emergency fund. Getting an extra 1% earns an extra $600 a year. Before considering taxes, remember that interest paid from a financial institution is subject to ordinary income tax rates. At your highest or marginal tax rate, assuming a 40% marginal rate, which is common for many high earners, this $600 extra you earned on your extra 1% really becomes $360. Now, I'm not here to scoff at $360. I just don't think 3 to 400 bucks this year is going to make or break any of your short or long term financial goals. But the difference between getting functionally 0% and 4.5% is $2700 pre tax and 1600 bucks after tax. Assuming that same 40% marginal tax rate. Again, I'm not saying you will get rich with an extra 1600 to 2000 bucks a year, but that buys some quality holiday gifts, a nice weekend away, and it's more than my clients pay me for their annual checkup each year. So it's definitely worth getting the 4.5%, but not worth bouncing your money from bank to bank to get a few extra tenths of a percent here and there. So a reasonable interest rate is the first quality we're interested in. The second is organizational opportunities. What I mean by that is some banks allow you to create buckets within your High Yield Savings account. I'm not talking about different accounts with different account numbers. These are sub accounts within the High Yield Savings Account that are earmarked for future expenses that we know will happen. We just don't know exactly when they'll occur. For example, we know we need to replace our cars, our home will need updating and repairs, we'll go on bigger vacations at some point and we'll have some large out of pocket healthcare expenses. To prepare for these episodic expenses, we recommend clients set up what we call squirrel funds where you squirrel away a little bit of cash every month into your High Yield Savings account via automatic monthly transfers. I personally use Ally bank for this in my life. Our High Yield Savings account has different buckets within the account that we deposit specific dollar amounts to every month via automatic transfer from our checking account. You may be wondering how we pick the amounts to squirrel away each month. For travel, we pick an amount that is some combination of currently true and reasonably aspirational. For us, that's $20,000 a year. We don't spend $20,000 every year on travel, but the squirrel funds roll over year to year and give us a guiding light for an average annual spending target. For out of pocket healthcare expenses, we pick the amount of our high deductible health plan individual deductible. Again, some years we use less, some years we use more. But this is a decent rubric for our healthy family of five. For home related cost, we save 1.5% of the value of our home each year. This is meant to cover big repairs, upgrades and sizable furnishings. Obviously, this amount doesn't get spent every year. It rolls over each year, and when Megan asks me if we can get such and such done on the house, I just open up my Ally app, show her the home bucket on my phone, and that gives us a ceiling on what we can spend and ensures we aren't undermining our other goals with the insidious and corrosive threat that is perpetual home renovations and updates. Same idea for cars. We take the number of cars in the family, the number of years we intend to keep each car, and the expected cost to replace those cars to come up with an annual savings target. We have two cars, plan to keep them at least 15 years and plan to spend about $25,000 to replace them. That math produces a monthly savings transfer of $278 to our car bucket. Then down the road when it's time to buy a new car, we're prepared to pay for it in cash. Other Squirrel funds that have been useful for other clients include saving up each year for your Future BackDoor Roth IRA contributions. So you've got $14,000 on January 2nd to do you and your spouse's backdoor Roth. You can save up for your annual disability insurance premiums. You often get a discount if you pay annually instead of monthly. People save up for weddings, big expensive cultural celebrations like bar mitzvahs or quinceaneras, a down payment on a home what some people call a 20s fund to gift to your young adult kids one day so that they can start their life and leave the nest. Or a Squirrel fund that I call surprises and demises intended for aging parents, pets or other loved ones whose present uncertainty may result in a large cash demand in your future. The way Squirrel funds work mechanically is that we pay for the expense on our credit card so you can get your 2% cash back or your miles or whatever makes you happy with your credit card. Then we reimburse ourself from the Squirrel fund back to our checking account. Then we pay the credit card bill from the checking account. The Squirrel fund then begins to fill up again because of the automatic monthly transfers. Our emergency fund sits in its own separate bucket. Squirrel funds and emergency funds are distinct and separate ideas. Squirrel funds are for inevitable future expenses that we know will happen. We just don't know when or how much. An emergency fund is the safety net that sits underneath the Squirrel funds in case an expense arises sooner than or larger than our Squirrel funds can handle. Having these Squirrel funds allows us to automate the rest of our financial life and to be reasonably assured that Any future expense will not disrupt our normal monthly cash flow. They are a great way to make additional use of your High Yield savings account because you're earning interest on all these buckets along the way. Okay, so now you have a good interest rate and some meaningful organization. If you're using a bank, you also have FDIC insurance. FDIC stands for the Federal Deposit Insurance Corporation. This government entity guarantees that you can get your money back if your bank fails and bank failures happen. This is not just a problem. In the 1920s. We've had some large bank failures in the last couple of years. And if that happens to your bank, the FDIC will return up to 250,000 for an account held by just one person and up to $500,000 for a jointly held account. In some cases, these financial institutions partner with other banks to ramp up their fdic insurance to $1 million to $2 million, depending on the account. You probably don't have a financial plan that calls for seven figures in cash, so this is probably not applicable to most people. For some people though, FDIC insurance provides meaningful peace of mind for large sums of cash. For other people like Jim, they don't care about this insurance or these squirrel funds. They just care about simplicity and interest rate. So often they don't use a bank at all. For their High Yield Savings account, they use a brokerage like Vanguard or Fidelity. Jim is especially fond of Vanguard because the settlement fund in a taxable brokerage account there is defaulted to the Federal Money Market Fund and that is currently paying just under 5%. Now, these money market funds are incredibly safe and incredibly liquid. They do not have formal FDIC insurance, however, but in exchange you often get a slightly higher rate than the banks. Not always, but often. Where you set up a High Yield Savings account and what the exact rate is at the time is not really important. What is important is just using one of them instead of these crappy savings accounts most people are using and not even realizing there's a better way. I hope that was helpful. If you have any questions, go to the blog and search High Yield Savings Account or send a Speak Pipe question into the podcast. Thanks for listening and have a wonderful day.

This podcast is for your entertainment and information only. It should not be considered professional or personalized financial advice. You should consult the appropriate professional for specific advice relating to your situation.