Finance

What is the rate of return I can expect on a savings account?

Prior to the Great Recession, savings account rates offered by banks could typically be found in the 4 to 8% range, depending on the inflation in the economy. Since that time, the Federal Reserve has undertaken unprecedented steps towards creating a low-interest rate environment. The average return on savings accounts had fallen to 0.06% annual percentage yield by October 2013.

When adjusted for inflation, the real rate of return offered by today's savings accounts is often negative. This has put many savers in a quandary, having to decide between losing liquidity and security or losing purchasing power with their savings.

How Savings Account Rates Are Determined

As a matter of principle, banks shouldn't offer a higher rate on their deposit accounts than they charge on their loans. For example, a bank would lose money if it offers 5% interest to its savings depositors but only charged 3% interest on its mortgage or car loans.

Banks can't just raise the rates that they offer on their loans to whatever they want; they'd lose out to competitor banks or other investment providers.

Savings account rates are chronically below 1% because the Federal Reserve offers to lend money to banks through its discount window. Banks can lend to each other at the interest level dictated by the federal funds rate. When both the federal funds rate and the discount rate are set below 1%, it wouldn't make any sense for a bank to pay more than that to receive money from private depositors.

Real Rate of Return

Don't just focus on the stated interest rate on your savings account to see how much it pays. Even if the rate on your savings account goes up by 5% next year, you might still be worse off if the inflation rate goes up by 7% over the same period of time.

Focus on the real rate of return to see how the purchasing power of your savings are changing over time. The nominal rate is just window dressing.

Compete Risk Free with $100,000 in Virtual Cash

Put your trading skills to the test with our FREE Stock Simulator. Compete with thousands of Investopedia traders and trade your way to the top! Submit trades in a virtual environment before you start risking your own money. Practice trading strategies so that when you're ready to enter the real market, you've had the practice you need.