The Federal Reserve (Fed) has been raising interest rates for a long period of time attempting to combat inflation and slow the economy which results in the increasing interest rates paid by savings options such as CDs, money market accounts, and savings accounts. In recent months, the economy is showing more signs of cooling off and annualized inflation rates appear to have hit their peak, or close to it for now. It takes a few months after interest rate adjustments by the Fed to have an impact and the slowing economy will likely result in lower, or no interest rate hikes going forward.
The slowing inflation and projections of either no interest rate hikes, or much smaller ones makes it a good time to lock in interest rates on saving vehicles that are long term such as, Money Market, High Yield Savings, or Certificates of Deposit (CD) accounts.
A Money Market account is an option where the interest rates are relatively high at this time averaging slightly under 4%, but will decrease over time, if the Fed keeps interest rates the same, or begins to decrease them. The Money Market account is a good option for investing your emergency fund money, so you receive decent short term interest payments with maximum liquidity. The interest rates are generally less than a High Yield Savings account, or CD account because of the flexibility provided with the withdrawal options available.
A High Yield Savings account is an option to secure higher interest rates in the short term which are averaging slightly over 4% without tying up your money in an account for years like you would with a CD. However, the interest rates are not as high as a CD and they will fluctuate if the Fed either keeps interest rates the same, or does not increase them as much. If that is the case, then the interest rate on funds in a High Yield Savings account will not increase much in the future. Also, if the Fed decreases interest rates as the economy softens, then the interest rate on the High Yield Savings accounts will go down. The High Yield Savings account generally has a higher interest rate than a Money Market account, because the funds in the account are less available, or there are withdrawal limits unlike the flexibility available from a Money Market account. The High Yield Savings account is a good option for savings when you may need the funds in the future, but not for emergencies in the short term and you do not want to tie the funds up for years.
Interestingly, right now, interest rates are experiencing an inverted yield curve, meaning short-term CD rates are higher than longer term CDs. In a normal rate environment, long-term CDs have higher average rates than short-term CDs. For instance, the average highest interest rate on a 5-year CD is around 4.45%, a 3-year CD is around 4.5%, and 1-year CD is around 5.1%. Therefore, locking in the higher rates at the height of the interest rate hikes by the Fed is a good idea for investing your available cash when you will not need access to the funds for a long time. The down side of investing in CDs is the lack of liquidity without being penalized, so make sure the funds will not be needed for the timeframe that you are locking in the interest rates for.
It is recommended that you set up a ladder CD where you lock in the interest rate for different timeframes by investing equal amounts of the cash that you will not need for years. The CD maturity timeframes that are recommended include 5-year, 4-year, 3-year, 2 year, and 1-year terms. When interest rates are changing over time, the ladder CD strategy to invest the cash will smooth out the interest rate yields compared to other savings options. The ladder CD strategy consists of purchasing a new 5-year CD as each CD matures in order to lock in the highest interest rates for the longest time. Even with an inverted yield curve, the ladder CD strategy will work by locking in current long-term rates that are slightly lower than the short-term interest rates, but still taking advantage of the higher-than-normal short term interest rates until the trend reverses and the yield curve is no longer inverted at which time you will lock in higher long term interest rates.
The bottom line is that interest rates are currently higher than they have been in many years, so it is a good time to invest available cash in one of the options mentioned above instead of retaining too much cash in a regular bank savings account paying very little, or a checking account paying little or no interest. The choice of which type of account depends on the ultimate purpose of the savings amounts, the required flexibility, and the likelihood of needing the funds for an emergency. The best strategy is to ensure you have money available for short term emergencies invested in a money market account, money available for long-term savings, or future spending in a high yield savings account, and funds invested for the long term that can be tied up for years in CDs, preferably using the ladder approach.
If you want to discuss where to save your available cash impacts, please reach out to me at George@Lydfordfinancial.com, or 602-510-7484