What to do as Interest Rates Change
As savers, we have been happily collecting interest at annual rates approaching five percent or more from our money market and similar accounts. After years of near zero interest rates, it has been nice to have an easy option for storing cash that doesn’t require a lot of thought or time spent hunting for the best CD yield and shuffling money around when your bank invariably slashes the renewal rate. However, with the recent cut in interest rates, and more expected to follow, times are changing. If you are wondering what you should do now as a saver, this article is for you.
First, a little history.
A Pandemic Followed By Inflation: 2020-23
The Federal Reserve, the central bank of the United States, sets the federal funds rate, the rate at which banks make short-term loans to other banks. Changes to this rate usually result in changes in the interest rates on savings and money market accounts, as well as short-term CDs and bond funds.
In March 2020, as the COVID-19 pandemic sent shockwaves through the global economy, the Federal Reserve slashed interest rates to near-zero levels. This emergency measure was designed to stimulate economic activity and provide stability during unprecedented times.
As the economy began to recover and inflation concerns mounted, the Fed initiated a series of interest rate hikes starting in March 2022. This marked the beginning of one of the most aggressive periods of interest rate increases in recent history.
By the end of this cycle, the federal funds rate reached a target range of 5.25% to 5.50%, the highest level in over twenty years.
The 2024 Pivot: Rate Cuts Begin
As we entered 2024, the economic landscape began to shift. Inflation, while still a concern, showed signs of cooling. The labor market, while resilient, began to show some signs of softening. These factors, combined with concerns about maintaining economic growth, led the Federal Reserve to reconsider its stance.
In a widely anticipated move, the Fed announced its first rate cut in September 2024, a one-half percent reduction. This decision marked a pivotal moment, signaling the Fed’s confidence that inflation was sufficiently under control and acknowledging the need to support continued economic growth.
The Fed is projecting another one-half percent in cuts in 2024 and an additional one percent in cuts in 2025.
What We Can Do
As interest rates decline, the yields on savings accounts, money market funds and CD renewals will decrease. Short-term bond fund yields will likely trend down as well, though the effect will be more gradual as the existing bonds mature and are replaced with lower-yielding ones.
We can’t control rates but we can be proactive to make sure we are getting maximum value for our savings. Here are some actions I am discussing with clients in light of the recent and expected cuts:
Consider How Much Cash You Need to Hold. Planners often recommend holding at least three to six months worth of living expenses in safe liquid accounts. Special situations like an upcoming tax bill or a large purchase may justify more. As rates have increased, it has been easy to let cash levels build - inertia is powerful. Now is the time to review your cash holdings across all accounts. If the balances look excessive, consider alternatives.
Take an Inventory of Your Accounts. Not all financial institutions adjust their rates at the same pace. It’s worth shopping around to ensure you’re still getting competitive rates on your short-term savings. It is easy to overlook an old account that may be paying below-market interest. Pay special attention to accounts at the large banks, which are notorious for paying lower rates.
Consider Locking in Rates. Locking in longer-term rates can seem counterintuitive when long-term rates are lower than short-term rates, as is the case now. As rates decrease, there is increasing value in pinning down the amount of interest you will receive over the next few years, particularly if it is enough to help you achieve your financial goals. There are many strategies to do this, such as a collection of CDs or government bonds with staggered maturity dates (known as a “ladder”).
Explore Other Options. With lower yields on traditional savings vehicles, some investors may want to consider other low-risk options for their short-term funds, such as short-term government bond funds, where the interest rate can be slower to decrease as the Fed acts. It is possible to lose money in short-term bond funds, but they are still relatively safe.