Oh, how quickly the tide can turn on savers.
At the start of the year, interest rates on savings accounts were about as high as they’d been since before the Great Recession. The Federal Reserve had just hiked its benchmark federal funds rate for the fourth time in 2018, making it the first year since 2008 to see that many rate hikes.
Six months later, interest rates on savings accounts have started to fall due to predictions of a Fed rate drop.
The Federal Reserve is widely expected to lower the federal funds rate — which would be the first decrease since 2008 — as early as a meeting scheduled for Tuesday and Wednesday of next week.
Once that rate drops, interest rates at the bank will really start to fall. The means now is the time for savvy savers to act. When savings account interest rates are sliding, a certificate of deposit (CD) becomes a more attractive risk-free shot at staving off inflation.
Fighting inflation with CDs
Inflation is below 2%, the Federal Reserve said in June, and the central bank’s target for inflation is 2%. That means your money is likely losing buying power if you aren’t earning at least around 2% interest on it.
For a year or two now, the most competitive banks — usually online banks — have offered interest rates as high as 2% if not higher on savings accounts and CDs. Those interest rates generally climbed higher after each Fed rate hike.
But just as the interest rates on savings vehicles tend to rise with a climbing federal funds rate, they tend to fall with a dropping federal funds rate, too. So, even if your savings account (like mine) still pays north of 2%, your interest rate is unlikely to remain that high in the face of Fed rate drops — unless you lock it in before the Fed starts dropping rates.
Putting your cash savings in a CD allows you to do just that: Lock in a specified interest rate for a specified length of time. Generally, CD terms can be as short as three months or as long as five years — or even more.
Selecting a CD is much like shopping around for a savings account: Basically, find out what interest rates multiple banks are offering on CDs right now. Or, use a free online resource like Money Talks News’ CD search tool to view multiple rates from multiple banks in one place.
Next, narrow your CD options by deciding for how long you are comfortable locking up cash savings. If you don’t want to tie up money for more than a year, for example, you need a CD term of one year or less.
CDs tend to pay higher interest rates than savings accounts, but it’s in exchange for you agreeing not to touch the money that you put in a CD for the length of the CD term. If you remove money from a CD before then, you generally will get hit with a penalty that effectively takes a chunk out of your interest earnings.
Another benefit of CDs
CDs are not the only way to earn a higher return on cash savings in the short term. But they are one of few ways you can beat inflation in the short term without risk.
Money in a CD, like money in a bank account, is insured. The Federal Deposit Insurance Corp., an independent federal agency, insures such deposits for at least $250,000.
You can verify whether a bank is FDIC-insured by using the FDIC’s free BankFind tool — and you should do that before transferring money to a CD.
What’s your take the latest news about the federal funds rate? What, if anything, are you doing to prepare for falling interest rates? Share with us by commenting below or over on our Facebook page.