The Pros and Cons of Variable Interest Rate Accounts

Variable interest rate savings accounts are often marketed as a new type of financial product, but in fact these types of accounts have existed for centuries.  These accounts were originally created as an investment vehicle for people who needed ready access to their money. Over time, as savings accounts at many banks became protected by government insurance, the interest rates that these accounts offered became lower and also stabilized.

Today, with such low interest rates being offered by most savings accounts, banks are looking for ways to get the average investor interested in using these accounts again. To attract attention, a few banks have started to offer these variable rate accounts again. However, determining if they are a good investment is complicated.

Variable rate accounts tend to have rates that fluctuate with current market rates. In many cases, this means that the rates are subject to change on a daily basis. There are several advantages and disadvantages to this.

By having the rates fluctuate more frequently, it is possible for an investor to make more on the money they place into one of these accounts. This is because a standard bank account will typically only change its interest rate once or twice a year. This rate is determined by financial executives who have to make a guess at what will happen to interest rates over the next several months. To protect the bank’s profits, they tend to guess low.

With a varying interest rate account, however, the interest rate is tied directly to several different market indicators. This takes the guessing out of setting the interest rate, and raises the potential for an investor to make money. In addition, the fact that the interest rate changes frequently means that an investor or saver is more likely to see a profit from a sudden rise in interest rates.

In the same way however, an investor could also see a sudden loss in their potential earnings. While most of these accounts have safeguards that prevent the investor’s principal from being lost, it is possible for the money in one of these accounts to earn nothing, and therefore lose value to inflation over time.

Furthermore, it is next to impossible for an investor to predict how his or her investment will grow over a set period of time. With a traditional savings account, it’s relatively simple math to figure out the profit that will be made off of any money that is deposited. On the other hand, an adjustable rate account behaves more like the stock or bond market. The potential profit is anyone’s guess.