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For savers, earning a competitive return isn’t just about seeing your balance grow – it’s about maintaining your money’s purchasing power over time. When your savings account’s annual percentage yield (APY) surpasses the rate of inflation, you’re actually growing your wealth rather than watching it slowly erode.
Understanding the relationship between savings rates and inflation
Inflation steadily decreases the purchasing power of your money over time. When prices rise due to inflation, each dollar in your savings account buys less than it did before. This makes it crucial to earn returns that at least match, and ideally exceed, the rate of inflation.
Think of it this way: If inflation is running at 3 percent but your savings only earn 1 percent, your money is effectively losing 2 percent of its purchasing power each year, even though your account balance is growing slightly.
The real cost of settling for low yields
Many savers leave their money in traditional bank accounts earning minimal interest, often well below the rate of inflation.
A seemingly small gap between your savings rate and inflation can have a major impact over time. For example, if your savings earn 0.01 percent while inflation runs at 2 percent, your money loses nearly 2 percent of its purchasing power every year. Over a decade, this could reduce your money’s real value by roughly 20 percent.
Settling for a low-yield account doesn’t just mean earning less interest – it means missing out on substantial earnings over time. The difference between a high-yield account and a traditional savings account can amount to hundreds or even thousands of dollars annually, depending on your balance.
How to find savings rates that beat inflation
Ultimately, the best rates on deposit accounts can generally be found at online-only banks. Some online banks offer higher APYs as a way to draw in customers from established brick-and-mortar banks, which often pay lower rates.
Credit unions are another common source of high APYs. Because they’re not-for-profit organizations, profits may be distributed among members by way of high yields on savings accounts.
In addition to APY, pay attention to factors such as minimum deposit requirements when shopping around for the best savings account. It’s also important to find an account with federal deposit insurance, as well as one that doesn’t charge monthly service fees.
CDs as an alternative to savings accounts
Certificates of deposit (CDs) can be another source of high rates from your bank or credit union. While Fed rate cuts could trigger banks to lower their APYs, opening a fixed-rate CD generally guarantees you’ll earn the same rate throughout the CD’s entire term — even if your bank lowers the yields on new CDs it issues.
In exchange for the guaranteed rate, however, the bank wants to hold onto your money for the duration of your CD’s term. As such, withdrawing the money before the CD matures will likely result in an early withdrawal penalty. This can eat into your interest and possibly even your balance.
Before dedicating money to a CD, make sure you won’t need the funds before the CD matures. Also, make sure you have money set aside for emergencies in a liquid savings account.
Bottom line
Earning a return that beats inflation is crucial for maintaining your money’s purchasing power over time. While specific rates will always fluctuate, the principle remains constant: seek out competitive yields from reputable financial institutions, and don’t let your money lose value in low-yielding accounts.
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