There’s really no way to sugarcoat it: interest rates on savings accounts are awful. Most are below 0.5%, and I wouldn’t expect them to improve in the near future. If you have $10,000 sitting in a savings account that pays 0.25% per year, you’re earning $25 per year on your money. That’s not a typo.

What can I do to earn extra interest?

The answer depends on what your goal is for the money that’s sitting in a savings account. If it’s money you will spend in the next year, you do not want to chase a higher interest rate by investing in bonds. The thing you should be most concerned with is how safe your money will be, as you will be spending it in a few months.

If the money you have sitting around is from stocks you sold during 2008, it makes sense to look at conservative bond investments that are offering a higher rate of return. If the money was previously invested, you probably weren’t planning on spending it in the next few years. In this case, knowing your account value six months from now probably isn’t your primary concern; rather, you are most likely looking to earn a reasonable rate of return over the next 3-5 years. If that’s the case, you’re not doing yourself any favors by stashing money away in a savings account.

I’ve got an emergency fund for unplanned expenses. I’m not planning on spending any of this money in the next year but I need to keep the money safe.

A good rule of thumb for your investments: if you use the word “safe” to describe some of your money, that portion should always be in an FDIC-insured savings account. Your emergency fund certainly qualifies, as it should be the first reserve you tap if something unexpected pops up.

So I’m stuck with an emergency fund that’s earning next to nothing in interest?

Yes and no. You’re stuck in the sense that I would strongly recommend keeping your money in a savings account, but you have options aside from a local bank savings account that you grew up with.

Online Savings Accounts

Over the last few years, online savings accounts have really grown in popularity due to the fact that they offer substantially higher interest rates. As an example, let’s compare ING’s popular Orange Savings Account* to a Regular Savings Account** with Bank of America:

ING Orange Savings Account: 1.25% (as of 1/8/2010)

Bank of America Regular Savings Account: 0.10% (as of 1/8/2010)

So what’s the catch? The main difference is that ING’s account is only available on the Internet. You open it online, and there is no bank branch that you will ever set foot in. You access the account through the ING Direct website, and you deposit money into your account by initiating an electronic transfer from your checking account. The reason that everything is handled over the internet is that ING saves a lot of money by not operating traditional bank branches, and these savings are passed through to you in the form of a higher interest rate. You do sacrifice smiling bank tellers, but you end up with an interest rate that is 12 times greater than what you’re used to.

While nobody enjoys earning 0.25% on their cash, it’s important to remember when you will be using the funds sitting in your savings account. The sooner you need it, the less risk I would recommend you take with those funds.

* Full disclosure: I have three ING Savings Accounts, and I’m very happy with them. I previously had savings accounts with two other online banks and ING’s account is much more user-friendly in my opinion.

** Yes, this is the actual name of the account on Bank of America’s website.

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