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Richard Barrington

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The Psychology of Money: Resist the Urge to Reduce Your Savings

Posted: 08/27/10 08:00 AM ET

If low savings account rates leave you discouraged, keep in mind what you can still do to make a difference over time. The worst thing you could do is let low rates on savings accounts lull you into a state of inaction.

The Psychology of Saving

There are two understandable, but potentially damaging, reactions to low bank rates:

  • Deciding that it isn't worth saving money when bank rates are so low.
  • Deciding that bank rates are so low it doesn't really matter which bank you choose.

On a gut level, these are perfectly understandable reactions. However, as described below, each is precisely the wrong attitude to take for the long-term benefit of your finances.

Good financial management is often a matter of fighting your natural psychological impulses. Dealing with low savings account rates is one of those instances.

Saving Works--Regardless of Rates

People naturally tend to be incentive-driven. If there is a reward for a given behavior, we're more likely to do it. Bank rates can be seen as a reward for saving money--and when bank rates are low, that reward has been substantially diminished.

However, saving money based on the reward from bank rates assumes that saving lacks its own merits--as if it were optional behavior. But for most people, saving is very much a necessity to prepare for retirement, a home down payment, or other major financial goal. You'll still need to save even if the interest returns are paltry.

As a matter of fact, if you've ever experimented with retirement planning calculators, you'll know that the lower the assumed annual rate of return to your money, the higher your personal savings rate needs to be to achieve a given financial goal. In other words, to make up for a low savings account interest rate, your personal savings rate must be higher, not lower, in order for you to meet your long-term savings goals.

Reducing savings may seem a logical reaction to low bank rates because it feels like you're not missing out on much, but increasing savings rates in these times is actually the more rational and necessary choice.

Always Seek the Best Available Savings Account Rates

FDIC figures from June 2010 show the national average savings account rate to be only 0.20 percent. Such low levels may make it seem hardly worth the effort to research rates. However, MoneyRates.com simultaneously listed more than two dozen savings accounts offering at least 1 percent per year greater return than that. At 1.20 percent or better, you could be earning six times the national average savings account rate, simply by looking for that high return. (In pursuit of the best savings account rates, don't forget to check on account requirements when choosing a bank. Monthly maintenance fees, overdraft fees, and ATM fees can more than erase your gains if you're not careful.)

All that work for 1 percent? Compound interest magnifies that advantage over many years. To put it differently, over 25 years of saving for retirement, that difference of 1 percent per year could compound to over $28,000 on a $100,000 average balance. Contrary to what your instincts might tell you, that $28,000 is well worth the time it would take to briefly shop around in pursuit of a higher savings account rate.

The original post can be found at MoneyRates.com
Savings Accounts: Resist the Urge to Reduce Your Savings