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New Fed Rate Hike? Save Smart

High-yield savings account? As if.

It’s easy to scoff after years of extraordinarily low interest rates. But with the March 15 Fed rate hike and more increases expected this year, interest rates are set to climb. So, experts say, the time to max out your savings account interest is now. You’ll put yourself in a position to fully capture gains.

With the possibility of fresh rate hikes in mind, NerdWallet looks at how much interest Americans miss out on and offers tips to get the best rates and save more money.

A $5.6 billion difference

Even with the current low rates, the difference between the highest- and lowest-interest accounts is significant. If every working American had a low-interest account of 0.01%, they would earn $51.5 million based on the average amount of personal savings.  But if they all had high-interest accounts, they’d earn $5.7 billion, a difference of more than $5.6 billion.

NerdWallet scrutinized data from several sources, including the Bureau of Labor Statistics and the Federal Reserve Bank of St. Louis, to determine how much interest Americans could be taking advantage of, how much they’re saving and how prepared they are to cover expenses in case of emergency.

Key findings:

  • Americans may be missing out on hundreds of dollars in interest annually: A high-yield savings account pays about $275 more per year than a low-interest account on savings of $25,000.
  • Consumers are saving more than a decade ago, but it’s still not enough: The average American in 2007 saved 2.95% of disposable income, but by 2016, that amount had grown to 5.85%, according to the Bureau of Economic Analysis. This is still, on average, only $2,540 per year, which probably wouldn’t cover the cost to replace your  transmission.
  • Consumers can cover more emergencies by saving their tax refunds: The average tax refund is $3,071, which could earn about $35 in interest per year and cover a variety of unexpected costs, including that transmission, a new water heater or a visit to the emergency room.

A high-yield account pays hundreds more

High-yield savings accounts aren’t what they once were. In 2006, savers could earn as much as 4.5% on their account balances, and today 1.10% is considered an exceptionally high rate. Still, an account paying 1.10% in interest earns about $275 more per year than an account with a rate of 0.01% on savings of $25,000.

Of course, not everyone has $25,000 in their savings account. The average American saves just $2,540 a year. If this is you, you’ll earn $28 more per year with that 1.10% rate. If everyone in the workforce in the United States, over 200 million people, picked the higher-rate account, they would collectively earn over $5.6 billion more in interest in a year based on this average personal savings rate.

What you should do

Switch to a high-yield savings account. You may not be impressed with an extra $28 — or even an extra $275 — in interest. But when rates go back up, and experts say they will, the account with 1.10% interest is going to be higher than the account with an annual percentage yield of 0.01%. The prime rate has started going up, and savings rates offered by banks will eventually follow.

“As interest rates increase, banks will want to lend more money, which means they need to incentivize consumers to deposit more money in checking and savings accounts,”  says Sean McQuay, NerdWallet’s credit and banking expert. “As a result, soon banks will be competing for your money by offering increasingly high-interest yields.

“Consumers shouldn’t wait to switch. Banks aren’t going to wake up one day and announce dramatically better APYs, so I recommend consumers switch over to a high-yield account sooner rather than later to make sure they capture as much of those gains as possible.”

You’ll mostly find these high rates at online-focused banks. Their overhead is lower, leading to decreased costs and more savings passed on to customers. You might also get a good rate at a credit union, though this may be specific to where you live or work. Find the best high-yield savings account for you based on your minimum deposit and ZIP code.

Americans are saving more, but it’s not enough

In 2007, Americans saved an average 2.95% of their disposable income, but by 2016, that  amount had grown to 5.85%, according to the Bureau of Economic Analysis. Although a significant improvement, this is still only $2,540 per year on average. And it’s not likely that all of this money stays in a savings account until an emergency comes along. It may be withdrawn for non-emergency purchases, and some of it may be locked away in retirement savings, which can’t be used in the short term without incurring steep penalties.

Many people save money to cover emergencies that will eventually come up. When comparing the average savings with the average cost of common emergencies, we found the stashed cash would cover the full cost of some of those unexpected events — but not all and definitely not more than one in a year.

You’ll notice that most of the emergencies can be covered — or mostly covered — by the average American’s annual savings. Unemployment is the exception. As shown in the table, the average American out of work for 26 weeks and receiving average unemployment benefits could exhaust a $2,500 emergency fund and still have more than $8,000 in expenses left over to cover.

Of course, when you’re out of work, you’ll likely be cutting back on expenses. But it’s unlikely, especially if you live in a pricey area, that you’d be able to fully bridge the gap between income and expenses without going into debt.

What you should do

Save more — or save something. It’s great that Americans are saving almost double what they were 10 years ago, but it’s important to save even more. Ideally, you should have from three to six months worth of expenses saved for emergencies. This may sound overwhelming and could take several years to accomplish, but every extra dollar you save puts you closer to peace of mind.

If the thought of saving more overwhelms you, start small. Add an extra $50 or 1% more of your net income to your savings each month. Once you have a steady increase, look for ways to widen the gap between your income and expenses. Essentially, to put more money in your budget, you need to make more, spend less or do both. Here are a few ideas for increasing the money you save each month.

“The best budget is like a good diet — one you can adhere to happily every day without it feeling like sacrifice,” McQuay says. “Finding that kind of approach to budgeting takes time and practice, but it’s worth it.”

Windfalls are key to helping cover emergencies

We get it, saving is hard, especially with the average cost of living in the United States rising faster than the average income. That said, the more people save, the more interest they earn and the more likely they’ll be able to weather an emergency. One way to get the ball rolling is by saving windfalls.

Putting away that chunk of money that’s over and above your income is a great way to boost your emergency savings. One of the most common windfalls at this time of year is your tax refund. The average refund is $3,071, which will earn an extra $34 in interest per year and can cover a variety of emergency costs, including a major car repair, a new water heater or an emergency-room visit.

Other windfalls include cash gifts, inheritances, rebates, lottery or gambling winnings, bonuses from work or the profits from selling something you own — basically any significant amount of money that isn’t included in your budget and, therefore, won’t be missed if you save it.

What you should do

Supercharge your savings with windfalls. If you got a tax refund of $3,071 and did nothing but add it to yearly savings of about $2,500, you’d be much better able to cover common emergencies. It can be tempting to spend extra cash on something fun, but if you don’t have the equivalent of at least three months of income in an emergency fund, or you have debt, or you’re behind on retirement savings, it’s a good idea to put most of it toward those financial goals.

“What helps me the most is setting specific goals for my savings,” McQuay says. “I don’t want to have to go into credit card debt if something unexpected comes up.

“I’m not saving just for the sake of it; I’m saving for financial freedom.”

Erin El Issa is a staff writer at NerdWallet, a personal finance website. Email: erin@nerdwallet.com. Twitter: @Erin_El_Issa.

Updated March 15, 2017.


METHODOLOGY

NerdWallet used a savings of $25,000 along with the data cited below to compare the interest earned in the highest- and lowest-interest savings accounts available through NerdWallet. $25,000 is approximately 26 weeks’ worth of consumer expenditures less entertainment and savings, according to the Bureau of Labor Statistics.

Labor force participation rate: data from the Bureau of Labor Statistics.

For the purposes of this study, we assumed the average savings of $2,540 was static — the balance wasn’t gradually increased and nothing was taken out during the year.

Personal savings rate and disposable personal income: data from the Federal Reserve Bank of St. Louis. Personal savings rate is the percentage of disposable personal income a person saves. This amount may be saved in savings accounts, investments, certificates of deposit, etc., but for the purposes of this analysis, we assumed total personal savings were being held in a savings account.

Average costs of emergency expenses: We found the average costs of a transmission, water heater and emergency-room visit. We also looked at the average duration of unemployment and the unemployment benefits for each state.

Average tax refund: Based on 2017 IRS data.