Many savings accounts are currently paying zero or very marginal interest rates and there is a reason for that which I wanted to explain in an easy manner since many people seem to wonder why this is.
Why you used to get interest
Historically you always got interest when you deposited money with your bank. Unfortunately that has changed over the last few years and most savings accounts today don’t pay any interest at all.
In a very simplified manner, this is how it works.
If I went to my bank and deposited 10,000 in a savings account around the year 2000, the bank took the money and put them in my account. At the end of the day, the bank had to deposit the money with the central bank, which in the US is called the Federal Reserve or the FED. If we look back to around year 2000, the FED would pay the bank (my bank) interest on the money they had deposited of around 5%. My bank would take that money and then pay me 3 – 4% interest on my deposit, keeping 1-2% as the bank’s profit.
The FED will change the interest rate it pays based on how the economy is doing. In good times, they increase rates and in tough times they lower the rates to stimulate the economy to be growing again.
Below is a chart of how the FED has changed their interest rates over the last few decades.
Why you no longer get any interest
As you can see on the above chart, the FED lowered the interest rates aggressively during/after the financial crisis in 2008 because of the rapid halt in the economy. By lowering the rate, the FED makes it cheap to borrow money and the intention was for corporates and individuals to start borrowing again and get the economy going. Unfortunately it did not have the effect they were hoping for so they kept on lowering the rate and then left it at 0.25% for several years! The reason for this was the economic situation which was really bad and unemployment reached 10% so they did what they could to get the economy back on track.
As this chart above is showing, never in the history of the FED had they lowered rates as low as they did now (says something about the severity of the situation).
The consequence for you as a saver is that your bank will no longer be paying you any interest. Because if you deposit money with them when the rate at the FED is 0.25% and you want 2% on your savings account, your bank would lose 1.75%! The banks are not in the business of losing money so they basically can’t pay you anything as there is no buffer anymore!
This is the simple reason why savings accounts no longer pay any interest, because the FED (or any other central bank) has set extremely low interest rates to get the economy back on track. The low rate makes it cheap to borrow (so great for those who borrow money) but the other side of the coin is that you won’t get any interest anymore as a saver.
What to do
If you want to get a better return than what the banks are currently offering, you will have to look at other alternatives. Safe alternatives like savings accounts pay very little at the moment which also means you would have to take more risk to get a decent return. To get more information and a better understanding of what alternatives are available and how they work, check out our financial sessions in the Wealth Section.
Actions to take:
If you haven’t yet, check out these posts:
- Learners are Earners and Earners are Learners!
- Number skills – why you have to know your numbers!
- Get a financial toolbox to serve you – for the rest of your life!
- The Language of Money – a language for life