Looking for a money market account that is worth your time?
You may be tempted to compare today's money market rates with years past when ING, HSBC, and others were offering 5.00% APY.
However, there are two sides to every coin; when banks were paying 5.00% APY, inflation was also high. For 2007 the inflation rate was 4.3%. For most of 2008, inflation hovered around 4.0%.
Here is a chart of the inflation rate from 2007 to 2010 (every month the inflation rate is calculated as a percentage change from the same month a year prior):
Since, inflation is really just a measure of how much consumer prices increase, it determines how much you can buy with your money.
Instead of focusing on the savings/money market rates, you should take into account the current inflation rate and your highest marginal tax rate bracket.
Here is a simple example:
Sam is single and earns a $35,000 salary – for 2004 this puts him in the 25% tax bracket.
In April of 2009, Sam put $10,000 into an HSBC money market account which at the time was paying 1.65% APY.
At the end of the year, Sam reports the interest he earned to the IRS and pays taxes on it.
Let's see if Sam is keeping up with inflation after paying taxes:
12 months of interest earned: $165
Taxes: $165 x 25% = $41.25
Effective After Taxes APY: 1.24%
Inflation Rate for 12 Months ending in April 2010: 2.24%
Net Return: -1.00%
What if Sam didn't put his money in a money market account at all? His net return would have been equal to the inflation rate: -2.24% loss in buying power.
So how can you beat inflation and taxes?
Suppose Sam had put his $10,000 into a 5 Year Roth IRA DiscoverBank CD earning 3.00% APY.
12 months of interest earned: $300
Taxes: $0 Roth IRA withdrawals after age 59 1/2 are tax free
Effective After Taxes APY: 3.00%
Inflation Rate for 12 Months ending in April 2010: 2.24%
Net Return: 0.76% APY
Over the next year, you should be able to beat inflation with an IRA CD.
According to ForecastChart.com's forecast, US inflation for the next 12 months will be around 1.04%.
You can check DiscoverBank's current 5 Year CD Rates at RateCatcher.com.
Sources:
http://www.moneychimp.com/features/tax_brackets.htm
http://data.bls.gov/home.htm
http://forecastchart.com