And you should give it to them—because most online banks will pay a premium to watch your savings for you.
A silent, deadly killer
This premium is important when you consider the debilitating effect inflation has on cash. Inflation is a reduction in the value of the dollar. In the seventies and eighties, inflation reached visibly destructive levels, but even at lower levels, inflation can wipe out spending power.
Over the past ten years (1996-2006), the value of the dollar has dropped requiring $1.28 to purchase what use to cost one dollar. Many of us have not noticed thanks to increased global trade and efficient companies like Walmart who have consistently driven prices down.
Traditional options
Traditionally, people had three or four options for inflation protection: savings accounts, certificates of deposit, money market funds, and for the affluent savers—short-term bond funds at their brokerage.
Savings accounts are the most convenient. When held alongside your checking account, savings accounts are very accessible. However, savings accounts at brick-and-mortar banks generally offer the lowest return on your money.
Certificates of deposit, more commonly known as CDs, provide a noticeably higher return on your money at the cost of reduced liquidly. The interest rate increases as you increase the term of your loan (to the bank). CDs allow banks to guarantee the availability of funds for personal loans, car loans, mortgages, etc.
Money market accounts are a flexible option that offers a return comparable to CDs. They invest in short-term debts (CDs, treasuries, commercial paper, etc), so your return fluctuates month to month. However, your savings are not committed for a time like CDs and most money market accounts offer check writing privileges which provides quick access to your money.
Short term bond funds are comparable to the previous option, unless invested in inflation guaranteed funds.
A new, superior option
With the advent of the internet, people gained a fifth option, online saving accounts which are FDIC insured. The past few years have seen many banks offer generous interest rates for online savings accounts. Some banks offer as much as ten times the amount of brick and mortar savings accounts.
Many online savings accounts have no account minimums, no fees, and allow quick access to your money. Transferring money to your checking account does take approximately three days; however, some banks offer ATM cards if you are interested in instant access.
In the end, the decision to open an online savings account comes down to your need for convenience versus your desire to earn a higher return.
Personally, I’ve enjoyed ING Direct and HSBC. For reviews and a list of more banks, check out My Money Blog’s list of online savings accounts and Get Rich Slowly’s bank comparison (make sure to read the 90+ reviews made by commenters).
Photo by Carlos