How Should I Save If the Fed Cuts Rates?

It's not all bad news for savers in a lower interest rate environment. Here's why.*

The post How Should I Save If the Fed Cuts Rates? appeared first on Discover Bank - Banking Topics Blog.

It's not all bad news for savers in a lower interest rate environment. Here's why.*

At the end of July 2019, the Federal Reserve (the Fed for short) cut the federal funds rate for the first time in more than a decade, ending a long era of gradual rate increases. The federal funds rate is the short-term interest rate banks charge each other to lend funds overnight. The Fed sets the federal funds rate and decides whether or not to raise or lower this benchmark interest rate in order to reach maximum employment and stable inflation.

Though you may not find the news of a Fed rate cut as exciting as watching your favorite sports team or getting the latest news about the royal family, you might still be wondering, “How does a Fed rate cut impact my savings?” and “How should I save if the Fed cuts rates?” Good questions. Important questions.

When the Fed decides to cut the federal funds rate, banks could cut the interest rates on deposit accounts such as savings accounts and money market accounts. This means you could earn less on the money you’ve stashed in these savings vehicles.

“For most people, this type of rate change in their savings account won’t lead to financial hardship,” says Eric Rosenberg, a former bank manager who now runs the consumer finance blog Personal Profitability.

When it comes to a Fed rate cut and savings account rates, it’s possible you could see interest rates lowered on savings accounts.

A Fed rate cut can also lower the amount of interest you pay to borrow money with credit cards, loans and home equity lines of credit (HELOCs). This means that in a lower rate environment, borrowing is actually less expensive, and the cash that you save could be used for spending or savings priorities. “You should always take a little time to make sure your money is in the best place and working to help you reach your financial goals,” Rosenberg says.

If you’re in a savings mindset, there’s no need to stress. When it comes to a Fed rate cut and your savings account, the news isn’t all bad. By understanding some savings and money management strategies, answering the question of “How should I save if the Fed cuts rates?” won’t be as confounding.

Here’s a primer on how you should save if the Fed cuts rates:

1. Find a competitive savings account rate

When it comes to a Fed rate cut and your savings account, consider looking for a more competitive interest rate. Online-only banks offer high-yield savings accounts that typically have better interest rates than your traditional brick-and-mortars. For example, Discover offers a high-yield savings account with an interest rate over 5x the National Savings Average.1 So, while rates may go down on average in a low-rate environment, you can potentially earn a higher interest rate on your savings if you research your savings account options.

If you're wondering how should I save if the Fed cuts rates, you may want to consider high-yield savings accounts or fixed-rate CDs.

When you consider a Fed rate cut and your savings account, remember that rate isn’t everything. You’ll also want to keep fees top-of-mind, as fees for maintenance, specific activities and maintaining a minimum balance can really put a dent in your interest earnings. Customer service and the online and mobile banking experience should also be on your list of considerations.

2. Leverage fixed-rate certificates of deposit

If you’re wondering how a Fed rate cut could impact your savings account, you’ll want to get acquainted with a fixed-rate CD. A fixed-rate CD is a deposit account with a set term, typically running anywhere from three months to 10 years. A benefit of a certificate of deposit with a fixed rate is that the interest rate is locked in for the entire CD term. Regardless of what the market does, money you put into a fixed-rate CD will continue to grow at the rate you receive when the account is opened. Nope. It’s not too good to be true.

If you’re planning for how you should save if the Fed cuts rates, consider opening a fixed-rate CD before rates start to drop or drop further. That will allow you to lock in a higher rate than what might be available later.

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“CDs give you the ability to save at a top interest rate with FDIC insurance,” Rosenberg says. “As long as you know you won’t need the money for a certain period of time, you can open up a new [fixed-rate] CD and keep earning today’s rate even if rates go down.”

If you save money in interest from lower borrowing costs following a Fed rate cut, you could also consider redirecting your savings to a certificate of deposit. “If your HELOC is linked to prime [which is based on the federal funds rate], then you can funnel your newfound interest savings into a CD,” says author and financial consultant Dr. Tisa Silver Canady.

If you’re considering a certificate of deposit when answering the question “How should I save if the Fed cuts rates?”, note that not all CDs come with a fixed rate. With a variable-rate CD, for example, you’ll typically earn a percentage based on the difference between the interest rates at the beginning and end of your CD’s term.

3. Consider bonds and stocks

When you’re considering how a Fed rate cut could impact your savings account, you may look beyond savings and into investments like bonds and stocks.

Since the Fed is trying to stimulate the economy when it cuts its federal funds rate, it’s possible that bond prices may increase.

“While [bond] yields will likely drop to some degree, you may also get higher yields than you would on other investments,” says financial expert and writer Miranda Marquit.

Marquit says that when the Fed’s short-term interest rate is cut, the stock market may perform better. If you’re wondering how you should save if the Fed cuts rates, Marquit adds that if you have the risk tolerance for it, the period after a Fed rate cut might be a good time to put a little extra in some of your investment accounts, such as stocks and bonds.

4. Keep some savings liquid

While the interest rate on a traditional savings account could decrease in a lower rate environment, there is still value in parking funds in this type of account. Even if you’re focused on a Fed rate cut and your savings account, there are factors to consider beyond interest income, after all. For example, money in a savings account is liquid, meaning you can easily withdraw cash if you have a short-term savings goal or an unexpected need.2

If you're considering a Fed rate cut and your savings account, plan to keep your emergency fund liquid in a savings account.

Experts typically recommend that you keep at least three to six months of expenses stashed in a savings account for your emergency fund. This is a fund that you draw on for unanticipated costs and curveballs (a plumbing nightmare, car repair, cough you can’t shake… you get the idea).

“If you need your money on short notice, your best choice is a low-fee, high-interest savings account,” says Rosenberg, the finance blogger. “While you may see your rate cut at some point, it is still the ideal for emergency funds and short-term savings.”

5. Pay off debt for long-term savings

If you’re thinking about how a Fed rate cut could impact your savings account, you actually may want to focus on credit and debt repayment. The idea is that with less interest earned on savings, you may want to consider using funds to pay off debt that’s incurring a higher interest rate. By paying off high-interest debt, you’re actually saving money over the long run by reducing interest payments.

If you have existing loans, you can also explore refinancing them. When there’s a Fed rate cut, you’ll often find lower rates than those that were available in a higher rate environment. You can then redirect the savings into a high-yield savings account, fixed-rate CD or investment vehicles like stocks and bonds.

Prepare your finances for a lower rate environment

Understanding how a Fed rate cut could impact your savings account and other aspects of your financial life can be important for your money management decisions. “We often think of policymakers debating things that don’t really impact us. However, the Federal Reserve’s monetary policy does affect our lives, and you need to be prepared for that reality,” Marquit says. By re-examining your savings and investment strategies, and understanding the implications of a Fed rate cut, you’ll be ready to respond.

One opportunity is understanding that the Fed rate cut and your savings account can work together, despite a possible interest rate decrease on your deposit accounts. The flip is that it also lowers the amount of interest you pay on things like credit cards and loans. So responding to those impacts accordingly with smart financial moves can make a positive difference for your hard-earned savings.

* This should not be considered tax or investment advice. Please consult a financial planner or tax advisor if you have questions.

1 The Annual Percentage Yield (APY) for the Online Savings Account as of 01/01/2021 is more than five times the national average APY for interest-bearing savings accounts with balances of $500 as reported by Informa Research Services, Inc. as of 01/01/2021. Interest rates and APYs are subject to change at any time. Although the information provided by Informa Research Services has been obtained from the various institutions, accuracy cannot be guaranteed.

2 Federal law limits certain types of withdrawals and transfers from savings and money market accounts to a combined total of 6 per calendar month per account. There are no limits on ATM withdrawals or official checks mailed to you. To get an account with an unlimited number of transactions, consider opening a Discover Cashback Debit account. If you go over these limitations on more than an occasional basis, your account may be closed. See Section 11 of the Deposit Account Agreement for more details.


Source: discover.com