Savings accounts are a type of deposit account for which the money deposited earns a fixed interest rate. Savings accounts are different from checking and time deposits, because funds in savings accounts can be accessed at any time by request to withdraw cash or transfer funds to another type of saving product. Technically there is no specific term that refers only to what we call “savings” as today’s banks offer many types of savings options like certificates, IRAs (Individual Retirement Accounts) and other investment vehicles offered under their bank-managed portfolios.
The highest interest rate savings account is generally a money market account where the interest rate is set by the Federal Reserve (the Fed) at a very low rate as is the case with a ten-year treasury note. In addition, if you have other money lending activities like home equity loans or mortgages, then the interest rate on your savings account will be higher than what you get from certificates of deposit (CDs).
The purpose of savings accounts is to maintain liquidity within an institution and reduce short-term risk associated with sudden withdrawals from an account. As such, most institutions are reluctant to open savings accounts that offer higher interest rates (dollar for dollar) than certificates of deposit because such investments are highly liquid and can be withdrawn in case of emergency conditions. This means that banks’ profit margin on savings deposits is lower than what they get from CDs.
This should give you room to compute the current return on your savings materials and whatever financial instruments that you already own to make sure that your returns are in line with this flat rate return. What does this mean once more? The return on your investment shouldn’t exceed the cost of these funds per month, i.e., if you invest $500 a month at 8% nominal return then 8% is what you should get in interest income.
What is a fixed rate of return?
The returns from stocks, bonds and other investments can vary based on the time frame when the investment is made. For example, if you invest $100 for three years at 5% annual return then after one year you will have a return of +5%, -2% and +2%. The total return of 10% is not guaranteed since one year after you will have a very different position in the market and your portfolio may be completely different from what you started with. In other words, return from investments varies quickly over short time periods like months or even weeks. This variation (called volatility) increases in time frames that are longer than one month like years or decades. The best way to combat this problem is to invest money at a very low cost (less transaction fees) over a long period (20-30 years) to achieve higher returns without this long-range variability in performance. A fund that has been around for 20 years or more will typically have lower volatilities (returns are usually quite stable compared with the returns from new launches).
