Bank accounts are a necessity in this day and age. But just like that deadbeat ex you might of had once, sticking to what you know and is familiar could be hurting your bottom line
The best online bank accounts are those, which provide you no fees and give you a decent savings interest rate on your balance. We all know that keeping too much cash isn’t a great idea due to inflation meaning that your purchasing power is actually eroding every year. So having a decent savings interest rate paid on your cash at around this rate lets you preserve your some of your purchasing power.
Before I get into how to get the best bank account, I want to give you a very quick and dirty run down on modern finance to keep everything in perspective and explain why I allocate assets the way I do.
The fact is that in today’s financial climate with historically incredibly low interest rates, cash is trash. Savers are most likely going backwards in terms of purchasing power, since the rate of inflation is higher than the interest you’ll receive on savings accounts or term deposits. Inflation is often called the ‘hidden tax’ on the working class. There is also a very real tax that hurts savers, which is the income tax that you’ll pay on the interest you earn from your savings.
So lets run through the math – lets say you’ve got $100K in your savings account, earning paltry 2% interest from a bank. At the end of the year, you’ve made a cool $2000 in passive income – great – or is it? If you’re an average worker, your marginal tax rate is probably sitting somewhere around 30%, that is, you’ll be charged tax on this interest as income at a rate of 30c in the dollar. The government does not factor in the inflation and loss of purchasing power; they just want the most taxation income. So the balance looks something like;
- $100,000 purchasing power start of year
- $2,000 interest
- -$600 income tax payable on your tax return
- -$3000 maximum theoretical inflation
Total purchasing power after 12 months: $99,000, PLUS a $600 tax bill leaves you with $98,400.
So by sticking your money in the bank, you just made a negative return of 1.6%. Even if you got a great interest rate of 3% equal to inflation, due to the effect of income taxation you still end up losing out of almost $1000, which is a 1% negative return on real purchasing power.
On the plus side, most governments have a savings deposit guarantee so even though you are losing money, you will know just how much money you will lose every year. In Australia, the federal government insures individuals for up to $250K worth of their savings – if the bank goes bust, you will still get back your savings (but only up to $250K). This isn’t really an issue, because if you wanted to spread out more cash investments I think you could just use multiple banks, each being federally insured for $250K, but for the reasons listed you’d end up going backwards over time.
Savers are penalised
Monetary policy is orchestrated to penalise savers; because savers are not great for an economy – stuffing your cash in your knickers draw or under the mattress doesn’t really help anyone (especially yourself!).
Spenders and consumers are good for the economy, as they stimulate business and production. This makes profits for business, which employ people. The spenders are then locked into being workers too, to continue to pay for all the stuff they are buying – meaning the nation has a strong workforce.
Investors are rewarded
If spenders are good for the economy, then investors are even better, and rewarded as such.
Investors may take their savings and invest it into the economy, such as buying shares in a business, which enables capital raising for business ventures. The concept of shares, and specifically buying of shares through low fee index fund ETFs is explained in my articles on index funds, how to get rich using shares and how to buy shares.
Bonds (fixed interest)
Some investors even invest in the nation directly, buying government backed treasury bonds – these are essentially an IOU from the government and a form of ‘bank free’ savings account. When a government sells you a bond (IOU) they can then use this money upfront for infrastructure projects or to pay off foreign debts. They promise to pay you back the amount of the bond (called the principle) at the end of the agreement term (called the maturity date). For your efforts, you are given a fixed rate of interest called a ‘bond coupon’ or the ‘coupon rate’, which is agreed upon when you purchase the bond. This is often referred to as fixed interest in a portfolio.
You can buy bonds from companies too, which is another avenue for them to raise money without having to generate shares and give investors all the associated rights that a shareholder would have over the company. The basic concept is the same: you buy a bond and hand over the principle, and then receive the coupon rate until maturity, where you get your money back. As an example, if you purchased a $100K bond with a 5-year maturity with a 6% coupon, you would theoretically receive $6,000 every year for five years, and then your $100K back on the end of the fifth year. You can see why fixed interest is such an attractive option for retirees then, who want a known source of income to live on.
So what happens when it goes wrong? This is where it all gets a little tricky. Companies can fail, or default on their debts if it all goes to shit. This might include not paying you your bond coupon rate or even worse not paying back your principle! If this happens, they can go into administration and liquidators could seize a company’s assets to pay off their debts. It’s a complicated process but usually secured creditors such as banks that lend directly against assets will get paid first (or they take control of assets and then sell them), then will governments, bond owners, and lastly the shareholders.
Companies that are at a higher risk of defaulting will need to pay a higher coupon rate to attract customers to buy their bonds. That’s why treasury bonds from AAA rated nations normally pay bugger all and have a low coupon rate, whereas CCC rated risky borrowers like start-ups, ‘sub-prime’ mortgage tranches or collateralised debt obligations have a much higher coupon rate. If your keen on learning more, plus seeing Margot Robbie in a bubble bath, do yourself a favour and Netflix the movie ‘The Big Short’
Gold does not produce a dividend. It just costs you money to store. The only way to make money with Gold is using the ‘greater fool’ principle, where a greater fool than you buys the gold for a higher price. I don’t invest in anything other than high quality businesses that produce dividends (which I buy through ultra low cost index fund ETFs) or cash flow positive assets.
Some people will try and time the market and flip gold; by buying gold and hoping for a stock market crash, they think that gold will go up in value and they will then be able to sell it and buy good quality stocks at a discount. Gold has historically increased in price roughly in line with inflation, so it has been a ‘store’ of wealth when compared to holding cash (fiat currency). Some people go so far as to delineate between money (gold) and currency (fiat dollars).
If you don’t have the appetite for a bonds, buying shares or being locked into using a ‘high’ interest savings account and losing purchasing power over time you could get higher returns using your existing loan. If you have a mortgage, you could put your savings into an offset account to lower the amount of interest payable on the loan – you could be saving 3.5% which is the average home owner mortgage interest rate.
That’s better than the rate you’d be getting on a savings account, but also has a hidden bonus. Saving money on your loan is not a form of income; the loan is debt – which means any money you save yourself is tax free. So that 3.5% whilst it doesn’t sound like much, should then by ‘grossed’ up by your marginal tax rate to give the representational return that other taxable investments would make. The average worker being charged a 30c in the dollar income tax rate would therefore be getting a grossed up savings of 4.55% – much higher than the savings rate any bank is offering now, and significantly higher than most AAA rated bonds.
OK back to bank accounts and cash. So even though you don’t want to have your capital sitting around as cash, you need a good savings buffer. I like to keep two years worth of living expenses, which is about 30K. This is because I am pretty frugal and a very aggressive investor due to my investment timeframe; FIRE in 2023 and then 70 years of living it up! I have the rest of my money invested in ETFs, and will shortly be settling on my first investment property (~2K down contract with 3.5% interest over a 30 year loan on a cash flow positive rental with good capital growth prospects).
Some people will need more cash than others due to having a larger family, owning their PPOR or by having a riskier or unsteady job. For home owners or property investors, as explainer earlier a convenient way to maximise your cash return on your emergency savings is to use an offset account on your mortgage: you still have access to the cash, but it is working much harder for you than it would in an online savings account. You probably still want a small emergency savings or ’Mojo’ account somewhere completely different just in case, and for quick access.
The best bank accounts
The best way to get a good account with no fee’s and a decent interest rate is to go with a discount online bank. By saving on overheads like offices and front of house customer service representatives, they can pass the savings on to you by charging little to no fee’s and giving you a decent rate.
In Australia, at the time of writing I think the following four are my top picks for an online bank; however the rates are changing frequently due to the RBA changing the cash rate. These banks provide good website and app interfaces, as well as a highly competitive rate amongst the other banks.
There are many other banks out there that offer a very short period of higher interest, but these quickly fizzle out and leave you with a paltry 1% or so. That is only going to assure you lose purchasing power through inflation and taxation! There are options for term deposits too, but I would steer clear of these as you don’t earn much more than these online savers, and your money is locked up and can’t be used in an emergency (so why the f wouldn’t you just buy ETFs with it instead). These banks will give you these rates on a condition though; they want you to either use their transaction accounts, have your salary deposited into them or make a regular monthly contribution to your savings accounts.
This is actually not a problem, because their transaction accounts are the best ones I have found – ING charges no fees ever, and provides a great exchange rate for overseas purchases. Ubank wants at least $200 a month deposit to qualify for the higher interest rate, however Rams is the only one which penalises you for withdrawing from your savings account.
A neat little ‘hack’ if you don’t have a large enough income (I think INGs threshold is only $1000 a month though) or if you can’t save as much as the threshold saving contribution you can just juggle money between accounts on automated online transfers to get the higher interest. It literally takes 30 seconds to set up and is incredibly satisfying.
If you want to start up an ING account (the best online bank account in Australia) and want $25 for free, use the following ING promocode…
If your still looking for ways to maximise your earnings, have a look at starting a fee free credit card. Making purchases on credit and paying them off on time means you’ll never pay interest on the credit, and your cash can be stashed away earning interest, offsetting your mortgage or better yet invested in ETFs. You can also get some ripper sign up bonuses like points, frequent flier miles or cashback and you don’t even have to keep the card – this is called credit card spoofing or hacking and it’s a fun hobby of mine.