Josh Dudick
Wealth of Geeks
Interest rates on savings accounts have increased over the past few months to levels not seen in decades. As savings rates continue to rise, many investors contemplate allocating more money into risk-free savings accounts instead of dicier assets, such as stocks.
How do today’s savings rates compare with stock market returns? Here’s what you need to know and should do as a savvy investor.
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How high are today’s savings rates?
The Federal Reserve has raised interest rates to curb inflation and improve economic growth. We are currently at the highest savings rates in 15 years, the highest levels in decades.
Today’s savings rates are significantly higher than in recent years. While the specific numbers offered will vary depending on the bank and account type, many banks now offer percentages well above the national average.
As of May 2023, some banks are offering rates of over 4%. This is a significant increase compared to the numbers of the past decade.
As a result of rising Fed rates, many banks have increased their savings percentages to remain competitive and attract more deposits.
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How do current savings rates compare to stock market returns?
Historically, stock market returns have been much higher than savings account rates. The S&P 500, often used as a benchmark for the stock market, has returned an average of around 12.3% per year since 1926.
In contrast, competitive bank savings rates are currently between 4-5%. For instance, Apple Card’s new high-yield savings account now offers 4.15% APY. That said, investing in index funds would likely yield a considerably higher amount over the long term.
While current savings rates may be higher than they’ve been in a while, they’re still significantly lower than historical stock market returns. It’s important to keep in mind that investing in the stock market comes with a higher level of risk. There are no guarantees when it comes to Wall Street returns, and investors should be ready to weather market volatility and potential losses.
Investors looking to prioritize higher rates of return should consider diversifying their investments by allocating some of their money to multiple countries and markets. This can mitigate risk and potentially improve returns over the long term.
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So what should investors do?
While higher savings rates may make it more tempting for investors to allocate more money into savings accounts, deciding whether to save or invest ultimately depends on an individual’s financial goals, risk tolerance, and time horizon. It’s important to consider both the potential returns and the risks associated with each investment option.
As the Fed continues to fight inflation, interest rates may continue to rise. This could make savings accounts more attractive to investors looking for a risk-free return on their money. Many investors may move money from their brokerage accounts to high-yield savings accounts.
However, it’s also important to consider the potential impact of higher interest rates on the economy and the stock market. If percentages rise too quickly, it could hinder economic growth and put a drag on the stock market. In this scenario, individuals and companies may consider saving instead of investing.
“With current inflation around 5-6%, I would only recommend shifting assets towards bank accounts if savings rates move about 7%,” says John Frank from Financial Freedom Countdown.
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Additional considerations?
There are additional considerations you should keep in mind when deciding between saving and investing.
One important factor to consider is taxes. Investments in long-term index funds or exchange-traded funds (ETFs) are typically taxed at more favorable long-term capital gains rates. In contrast, taxes on the interest income from savings accounts is less favorable than ordinary interest rates. This means long-term investors holding stocks or index funds for more than one year may benefit from paying lower tax rates on their investment gains.
In addition, holding stocks or index funds can allow for more efficient compounding of returns over time because investors do not have to pay taxes on their investment gains every year. This helps maximize the growth potential of your investment portfolio.
It’s worth noting that the tax benefits of investing in stocks or index funds are more significant for higher-income investors in higher tax brackets. Lower-income investors in lower tax brackets may not see as much of a difference in tax treatment between investments in stocks or index funds and savings accounts.
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What’s your risk appetite?
While current high savings rates are attractive to risk-averse investors, they’re not a viable long-term alternative to the stock market for most investors seeking long-term returns. Stocks historically provide higher long-term returns, although they come with higher risk.
Investors should also consider the impact of taxes on investment returns and make sure to diversify their portfolio across multiple asset classes and tax-advantaged accounts.
That said, if savings rates continue to rise, investors should keep an eye on current bank savings rates and consider reallocating more money to high-interest savings accounts. As rates continue to increase, prioritizing savings over investments may become more rational, especially for risk-averse investors.
As always, it’s essential to consider individual financial goals, risk tolerance, and time horizon when making investment decisions.
