How do Savings Accounts Work in a Zero Interest World?

To answer this question, you’ll need to know a little bit about the Fed’s rates and how the banking system works.

The Fed raises or lowers interest rates to keep the U.S. economy running smoothly so that unemployment stays low and inflation doesn’t get out of control. The interest rate that the Fed directly influences is the Federal Funds Rate, which is the rate at which banks borrow money from each other to make up for funding shortfalls if, for example, a lot of customers withdraw their deposits at once. But banks borrow these funds for very short periods of time, typically overnight. The financial crisis of 2008 showed us that when banks become too reliant on such short-term funding, they can become unstable. As a result, banks are now required to keep larger amounts of “stable funding” – in other words, money that can’t easily be withdrawn.

You can withdraw all your money from a standard savings account or interest-bearing checking account without notice. And if you do, the bank might have to borrow overnight from another bank to balance its books. To obtain more stable funding, banks provide a range of products with higher interest rates but which tie up your money in various ways, such as high yield savings accounts and certificates of deposit (CDs). To encourage you to move your savings into these products, banks pay much lower interest on standard savings accounts. Typically, they pay about the same as they would have to pay another bank for overnight funds – which, in a zero-interest-rate world, is pretty much zero.

So, one way of increasing the return on your savings is to move them into higher-yielding bank products, if you can afford to tie up the money for a while. There are three basic types:

• High yield savings accounts.
• Money market accounts.
• Certificates of deposit.

Like standard savings accounts, high yield savings accounts are FDIC insured. This means your money is safe and backed by the full faith and credit of the U.S. government, provided your balance doesn’t exceed the FDIC limit of $250,000. But the interest rates on high yield savings accounts are far higher than on standard accounts. In May 2020, the annual compound interest rate, or Annual Percentage Yield (APY), on high-yield savings accounts was as much as 1.5%, compared with an average of 0.06% on standard accounts.  For more about APY, see “The Differences Between APR, APY, and Interest Rates.”

However, higher APYs on savings accounts come with strings attached. You may have to make a minimum deposit to open the account, such as $500 or $1,000. You might have to agree to pay an amount, like $100, into the account monthly. And if the balance on your account drops too low, the interest rate could fall sharply, or you might have to close the account. Additionally, there could be annual or monthly service charges. It’s worth comparing the APYs, conditions, and charges on different high yield savings accounts to see what works best for you.

Although high yield savings accounts offer much higher interest rates than standard accounts, they are not immune from Fed interest rate changes. High yield savings account APYs have fallen since the Fed cut rates to zero,³ and they could fall more if the Fed were to introduce negative interest rates. However, they would likely rise if the Fed raised rates.

Many high yield savings accounts come with online tools that you can use to move money from your high-yield account into your checking account for spending purposes. Additionally, you may be able to use ATMs, and some banks provide checks or a debit card. However, high yield savings accounts aren’t intended for everyday spending. You can deposit money as often as you like, but Fed regulations limit withdrawals from the account to six per month.⁴

Money market accounts are a special type of savings account intended for large amounts of money. The money in them is invested in securities such as U.S. Treasury bonds. They typically offer interest rates above those on high yield savings accounts, but lower than CD rates. There is usually a minimum balance, which can be as high as $2,500 – the interest rate can fall sharply if the balance drops below the minimum. As with high yield accounts, the interest rate can change, so if the Fed cuts rates, the interest rate on your money market account could fall.

Money market accounts offer similar facilities to high yield accounts. Money can be deposited or withdrawn at any time using online transfer or via ATMs, and some accounts have checks or debit cards. As with high yield accounts, the number of withdrawals per month is restricted by law to no more than six. There may also be maintenance charges.

Despite their name, money market accounts are banking products, and therefore benefit from full FDIC insurance up to a limit of $250,000. In this respect they differ from Money Market Mutual Funds (MMMFs), which don’t have FDIC insurance. As MMMFs are also sold by banks as investment products, it’s important to check the terms and conditions carefully to ensure you are buying an FDIC-insured money market account.⁵

If you know you won’t need to withdraw your money for some time, you could opt for a CD.

You can buy CDs with maturities ranging from one month to five years. CDs typically offer higher interest rates than high yield savings accounts, and the interest rate on a CD typically rises with the maturity: a one-month CD might pay close to zero, but a five-year CD would offer considerably more. In May 2020, some five-year CDs were paying over 2% APY.

Importantly, the interest rate on a CD is fixed, which could be helpful if zero interest rates became negative rates, as has already happened in Europe and Japan. However, if interest rates rise, it might be difficult to take advantage of them because there is typically a penalty for withdrawing money from a CD before its maturity date, which could wipe out the benefit of moving the money to a higher interest account. CDs typically have a minimum investment amount, and some also have a maximum. And unlike high yield savings accounts, CDs won’t offer checks, debit cards, online transfers, or ATM access.

Like other bank savings products, CDs benefit from FDIC insurance up to a limit of $250,000 per customer in any one bank.