When the Fed changes interest rates, consumers feel the effects in a variety of ways.
For savers, banks that offer high rates tend to pay more when the Fed raises rates and pay less when the Fed lowers them. The Fed has raised its target for the federal funds rate seven times in 2022 — most recently by 50 basis points in December — and further hikes are likely in 2023.
“The outlook for savers has improved as the Fed has raised interest rates to keep inflation in check,” said Greg McBride, CFA, Bankrate’s chief financial analyst. “But where you put your money really matters. The highest-yielding savings accounts and certificates of deposit are still hot as these banks ramp up payouts to stay competitive with savers’ money. But they’re not going anywhere until they’re passing higher interest rates on to savers. On the other hand, many banks – especially the large ones – remain very nervous.”
For anyone looking to make saving their money a top priority, here are a few things to keep in mind when the Fed changes the federal funds rate.
How the Fed Affects Deposit Rates
The Federal Reserve sets the federal funds rate, which determines what banks charge for borrowing money. These rates, in turn, affect the annual interest rate on savings accounts—these changes don’t happen overnight. When rates rise, APY usually follows, but for weeks or months.
While banks typically set the APY for their deposit accounts based on the direction of the federal funds rate, the timing and exact rates may vary. “Some of the big banks are taking deposits a lot without having to pay to take more deposits,” McBride said. As a result, account interest rates can vary significantly from bank to bank. “It’s important for consumers to do their research, according to McBride. “The top-yielding CDs are at levels we haven’t seen since the 2009 CD.
Savings accounts have an average APY of 0.19% and one-year certificates of deposit have an average annual interest rate of 1.23%, according to Bankrate. A one-year CD costs about 4.50%. Those rates are much higher than a year ago, but still not enough to keep up with 7.1% inflation. Still, now is a good time to assess your savings rate and look for opportunities.
What savers should do
While the average return on traditional savings accounts is a paltry 0.19%, some banks offer high-yield savings accounts with annual interest rates closer to 4% — nearly 21 times that figure. These accounts won’t do much to offset rising prices at gas stations and grocery stores, but they will help you earn some money.
“High inflation and reduced purchasing power don’t offset emergency savings,” McBride said. “The main benefit of emergency saving is not the rate of return you earn, but instant access to cash when unplanned expenses arise, protecting you from heavy debt or forced asset sales.”
Online banking has a reputation for offering the highest returns, but it’s worth a try. Also consider cash management accounts and money market accounts to find the best deals. If you can park your money for a while, consider short-term CDs.
“For investors looking for predictable interest income, a CD will provide that without the price volatility and fear of default that many bonds have,” McBride said. “Just don’t sacrifice your emergency savings to chase returns on CDs unless the bank offers a way to cash out early without penalty if the money is needed.”
When looking for the best deal, read the fine print about fees and minimum balances, and verify that the account offers the features you need.
“When you’re shopping at the market today,” says Simon Guerre’s Cowell, “go online to compare prices and choose a brand you trust.”
Tips for Finding the Right Savings Account or CD When Interest Rates Are Rising
Keep in mind that well-known brand-name banks with larger marketing budgets aren’t the only ones offering competitive savings account and CD rates. Community or regional banks, credit unions, and online-only banks often offer higher interest rates on deposit accounts to attract new customers.
“[Savers] need to think carefully about which savings accounts or CDs [they open],” The Smart Investor CEO Baruch Silvermann wrote to CNET in an email. “In times of uncertainty like this, it may not be a good idea to freeze funds for an extended period of time. You may want to have the flexibility to move your funds freely if a better opportunity arises.”
“[When] you look at CDs, focus on shorter maturities so you can reinvest or roll over your money at maturity. Or, if you don’t incur withdrawal penalties, go for a longer-distance CD, ’ added Silvermann.
The best high-yield savings offer 2% to 4% APY with low fees and no minimum balance requirements, and the best CDs offer rates over 4%. When evaluating savings accounts, be aware of any fees associated with opening or maintaining an account. You should also compare the APY and how easy it is to get your money before making a decision. CD prices vary by institution and term.
CDs offer a safe, fixed rate of increase – as long as you can keep the money in the account until the maturity date. Duration can vary from three months to five years or more. Before opening an account, make sure your deposit is insured by the FDIC or the National Credit Union Administration up to $250,000.