On November 9th, 1993, the lyrical geniuses of The Wu-Tang Clan proclaimed “cash rules everything around me dolla dolla bill y’all” in their hit song C.R.E.A.M. Their album, Enter the Wu-Tang (36 Chambers), was raw and controversial, but their message around cash was not. Back then, inflation was ~2.75% and a savings account could yield 3% to savers. In other words, cash WAS a viable vehicle in which to store wealth as it provided protection against inflation.
Since the 2008 economic crisis, inflation has hovered between 1 and 2% while a savings account has been paying you less than 0.25% interest a year. Basically, the value of your savings has been falling by 1 to 2% every year. So cash, as far as most people can remember, has NOT been a viable vehicle in which to store wealth. But here comes the curveball. By the end of this year, a high-yield savings account could be earning you above 2% a year. I know, crazy right?
Why is this happening?
After keeping interest rates at zero from 2008 to 2015, The Federal Reserve has raised them to 1.5%. If the economy holds up, the Fed is supposed to raise them above 2% over the next year. (To learn why the Federal Reserve does what it does, read Is the Fed Leonard from Memento?)
Banks do not necessarily have to raise the savings account interest rate just because the Fed raised short-term interest rates, and, in fact, they didn’t for a while, but now you can find savings accounts yielding 1.65% returns as competition for savers heats up.
How does this affect me?
As we discussed in our Guide to Investments 101, one of the biggest decisions you have to make once you are saving some of your hard earned money is to either invest in the markets (i.e. stocks & bonds) or to stash it into a savings account. We, at Zoe, believe it is important to establish an emergency fund even before you start investing money towards your medium- or long-term goals. Why? As we discussed in Doomsday prepping, adding a little crazy to your personal finances, keeping the equivalent of 3 – 6 months salary aside acts as a buffer so that you don’t have to take money away from important monthly bills like mortgage payments, school fees or even better, you don’t have to adjust your lifestyle in any way. As emergency funds are normally held in savings accounts, the good news is that they can now yield ~1.6% compared to 0% just 10 months back.
Once the emergency fund is out of the way, the next task is to figure out how your bond allocation compares to having money in your savings account. For instance, if you had bought a five-year Treasury bond back in 2016, it would yield 1.8% return. During the same period, a high cash savings account would yield ~0.25%. So you would have received a 1.6% (1.8%-0.25%) increase in your yield (or return) for locking up your money for 5 years. Now, however, the spread between what a five-year Treasury bond returns and your cash savings account is only 1.1% (2.8%- 1.65%.) In other words, the bond market is not compensating you as much as it used to for locking up your money relative to a savings account. So let’s say you were thinking of buying a home three years out, keeping your money in a high savings account might start to make more sense than buying a bond that matures in three years, as it keeps your money from being locked up for the three years at a particular rate.
From a long-term investment perspective, a savings account alone will not allow your money to grow very much and it’s, therefore, best to have a mix of stocks, bonds, and cash – the proportions of each depending on your goals, risk tolerance, and risk capacity.
The Wu-Tang Clan released its 8th album labeled The Saga Continues on October 13, 2017, (not this Wu-Tang Clan) which coincided with the return of a savings account that yields more than zero. Coincidence? I don’t know. What I do know is that the classic song C.R.E.A.M might start to resonate with Americans more so than it has over the last decade.
If you enjoyed this post, check out Doomsday Prepping, Adding A Little Crazy To Your Personal Finances.
If you have more techincal investing questions, it could be good to consult a fee-only financial advisor.