Q: If one were to deposit $1 million into a savings account paying 5 percent, how much money would one expect to receive in a year?
A: That's an easy question to answer, though it should be pointed out up front that the answer is purely hypothetical. Savings accounts yielding 5 percent were a victim of the financial crisis eight years ago, and current bank rates are nowhere close to that.
Compound interest for $1 million in a savings account
To start with the theoretical answer, a $1 million savings account paying 5 percent would earn $50,000 a year. The nice thing about the way interest compounds is that if you left that interest in the account, it would then earn interest the following year, so that the account would produce $52,500 the following year.
Unfortunately, the reality is that while 5 percent savings accounts used to be commonplace, they are nothing more than a pipe dream today. The most recent MoneyRates.com America's Best Rates survey found that the average rate on savings accounts is 0.224 percent.
Using a compound interest calculator, this savings account rate would produce just $2,243 in annual interest on $1 million dollars. Money market rates averaged 0.182 percent, which would produce even less interest.
The America's Best Rates survey found that the best high yield savings accounts are paying about 1 percent, which would yield $10,000 on $1 million. That is more than four times better than the average savings account, but still well short of the $50,000 that a 5 percent yield would produce.
Alternatives to low-yield savings accounts
Today's low yields have many savers scrambling for alternatives. There are ways of potentially earning more interest, but each comes at a price. Here are some examples:
1. Certificates of deposit
If you were willing to commit your money for five years and search for the best CD rates, you could probably earn about 2 percent. Be advised, though, that you would probably also face a penalty if you wanted to access any of your money before the end of the CD's term.
2. US government bonds
30-year Treasury bonds are currently yielding about 3 percent. That is higher than even the best CD rates, but the catch is that the price of the bond may fluctuate widely between now and the maturity date 30 years in the future.
3. Corporate bonds
Debt securities issued by corporations pay a variety of yields that will be higher than the yields on Treasury securities of the same length. However, the higher the yield, the more risk the marketplace perceives that the corporation won't be able to meet the interest and principal obligations of the bond.
4. Foreign bonds
These carry the default risk of corporate securities, and also introduce an element of currency risk that can wipe out any yield advantage.
The above are all legitimate alternatives for earning a higher yield than current savings accounts. But as you can see, each also carries some degree of additional risk. If anyone offers you a guaranteed yield of 5 percent these days, you should be very wary - it is likely such a scheme goes beyond risky, and is an out-and-out scam.
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