I am not surprised that my recent suggestion to start the decade off right by opening a high-yield savings account received a lukewarm reception. With rates between 1% and 2% APY right now, these savings are looking somewhat pathetic.
Savings accounts are not designed to be investments. They will not provide the growth potential that stocks provide over the long term, nor do they carry the risks that are associated with the stock market. Even if the bank holding your savings account fails, you will be able to withdraw your money. I’m sure there are many people who no longer produce an income through working, people who rely on their investments to sustain them, who were wishing their investments were insured by the FDIC, particularly right after the stock market crashed.
Money market accounts are not alternatives to savings accounts. There is no inherent difference between a money market account and a savings account. Some banks may allow you to write checks from your money market account, but you’re probably limited to three. Money market accounts are subject to the same federal limitations on withdrawals as savings accounts: only six per statement cycle. Money market accounts sometimes offer interest rates that are higher than savings account rates, but there are often other limitations like monthly fees, minimum balances, and a tiered interest rate system that benefits higher balances.
By law high-yield checking accounts can’t exist. But banks generally get around that law by creating Negotiable Order of Withdrawal (NOW) accounts, calling them checking accounts in their marketing materials. They function the same as as a proper no-interest checking account as you might expect, but banks are allowed pay interest on the deposits. You can likely find checking accounts offering interest rates even higher than high-yield savings accounts, but they usually come with limitations like a direct desposit requirement or other limitations like many money market accounts.
Money market funds are different than money market accounts. These are investments, mutual funds, and they carry slightly more risk than savings and money market accounts. You might find a slightly higher interest rate in a money market fund offered by your bank or brokerage. Money market funds often offer check-writing privileges as well.
Investments in peer-to-peer lending are not like savings accounts. If you pick the right investments, you could earn more than you would in a savings account. Lending Club makes this process easy. It’s important to note that you don’t have immediate access to your money when you invest through Lending Club. With a savings account, you can withdraw your money at any time, but that is not how peer-to-peer lending works.
With Lending Club, if you need to withdraw before your loans are paid back or your investment matures, you have to sell your investment on a secondary market. This could take a few days and you probably won’t be paid the full value of your investment. Additionally, these investments carry the risk that the borrowers will not repay the loans. It’s important to make these distinction when aggressive marketing campaigns gloss over the details.
Peer-to-peer lending services are providing good services by connecting borrowers and lenders directly rather than involving the banking industry. I want to highlight another alternative with a similar mission.
Savings accounts at community banks and credit unions are good options because they also offer FDIC or NCUA insured deposits and often provide interest rates as high as high-yield savings accounts with major online banking institutions. When any bank receives a deposit into your savings account, such as your paycheck, the bank can then lend part of that money out to borrowers. With community banks, your money is more likely to stay within the community in which you live, assisting small business owners and supporting economic development your town.
If you are concerned that by depositing your cash into Citi or Bank of America you are supporting companies that are “too big to fail” and require bailouts from taxpayers, yet still find ways to pay executives outrageous bonuses, then you may want to consider community banks. I found this video, produced for the campaign to Move Your Money (out of big national banks and into community banks), thanks to @ericalucci. The short film draws inspiration from and samples It’s a Wonderful Life.
Updated June 23, 2016 and originally published January 5, 2010. If you enjoyed this article, subscribe to the RSS feed or receive daily emails. Follow @ConsumerismComm on Twitter and visit our Facebook page for more updates.