Interest Rate Hikes Are in Full Swing. Have You Positioned Your Savings Accordingly?

The U.S. Federal Reserve raised interest rates by 0.75% for a second consecutive month in July 2022, following a hike of the same amount in June. Fed leaders have witnessed inflation continue to persist in 2022 despite the measures the central bank has taken since spring to tamp down rising prices; the Consumer Price Index, a key inflation indicator, showed a year-over-year increase of 9.1% in June, the largest jump over a yearlong period since 1981.

Climbing prices and the rising cost of borrowing are shaking consumer confidence. But if there’s a bright spot in the troubling economic forecast, it’s that rising rates have energized the market for savings products to a level not seen in years. And even though inflation is high, savings are even more important because market volatility and underperformance have been impacting investors’ portfolios.

As the U.S. Federal Reserve’s actions to hike up interest rates cascade through the economy, financial institutions are competing to offer more attractive rates on savings products.

Those with cash savings have an opportunity to put those funds to work to generate passive income. In fact, against the backdrop of seemingly persistent inflation, it’s critical that savers earn market-leading returns on their cash reserves to help retain as much of its value as possible.

Over the course of the pandemic, many Americans went on autopilot in how they held savings. Stimulus checks and other unspent cash just sat in checking accounts, earning effectively nothing. The tide has shifted dramatically, and savers should snap out of that passive approach. Waiting to make changes in their savings strategy means missing out on increasingly attractive returns.

All through 2020 and 2021, savers didn’t witness a meaningful upward climb in the interest rates they earn on deposits held in financial institutions. The Federal Reserve, which has tremendous influence over prevailing interest rates, had positioned them at historic lows for the past couple of years as part of its efforts to prop up the American economy amid the Covid-19 pandemic. Many financial institutions in turn offered interest rates on savings products well below 1%; in fact, as recently as December 2021, the average interest rate for a savings account was 0.06%, as tracked by the Federal Deposit Insurance Corp. Other factors — including the aforementioned glut of cash deposits flowing into financial institutions in the wake of government stimulus programs — also contributed to the low rate environment.

But in the final months of 2021 and in early 2022, the Fed indicated that it may back off the measures it has followed that have held rates at near-zero levels. And in mid-March the Fed made good on its signals: The Fed announced that the Federal Funds rate was increasing by 0.25%, to a target range between 0.25% to 0.50%. (The Fed employs a set of implementation tools, such as adjusting the interest on reserve balances rate [IORB] it charges to banks, to keep the Fed Fund rate steady within the stated target.) Again, this benchmark rate had been kept at historic lows for years. This is the first upward bump since 2018. In May, another hike was announced, further increasing the Federal Funds rate by 0.50%, to a target range between 0.75% and 1.00%. The Fed’s June meeting resulted in another rate increase, of 0.75%, reaching a target range of 1.50% to 1.75%.

By raising the Fed Funds rate by another 0.75% (or 75 basis points) to a target range of 2.25% to 2.50%, the central bank is signaling that aggressive action is still needed to cool the economy and rein in price increases.

Many observers expect the trend to continue through at least September if not longer.

Savers may be wondering how briskly banks and credit unions are passing the interest rate increases onto them in the form of better-performing saving products. Raisin’s proprietary research indicates that rates on savings products are climbing faster than they did in previous cycles where prevailing interest rates rose. In other words, financial institutions are acting more responsive than usual to adjust product offerings to meet the moment.The prospect of a prolonged rising interest rate environment raises important questions for savers: What’s the right strategy for me to navigate the interest rate tailwinds that are expected over the coming months? And how can I capitalize on the opportunity for higher yield?

Check out the following tips for navigating a rising interest rate environment.

In a rising interest rate environment, it’s possible that financial institutions will begin to dial up the APY (annual percentage yield) they offer on their deposit products in order to keep those products competitive and in step with broader market conditions.

Savers who park their cash in a savings product like a high-yield savings account or money market account (also known as a money market deposit account) can benefit from these rate hikes because this type of product tends to offer an interest rate that fluctuates when there are underlying shifts in interest rates across the broader economic landscape.

A money market account and a high-yield savings account aren’t likely to impose limits on deposits or withdrawals, so they offer a high degree of liquidity. For holding cash you don’t expect to need for day-to-day spending, this savings vehicle makes a lot of sense.

But this leads to the next key point…

When interest rates rise, it’s more attractive for banks and credit unions to lend out money. But to do that, they need inflows of cash — or deposits coming from savers like you. Increased competition among financial institutions, as mentioned before, can lead to the introduction of new and more attractive savings products. Savers who have defaulted to adopting whatever savings products their local bank or credit union offers should pause to consider exploring online savings accounts, which may offer much more competitive rates.

Another common misconception to reconsider is: Well, if rates are only going to continue to go up, I may as well wait to switch savings products, or change up my financial strategy. The problem with that approach is, you miss out on earnings today.

Plus, it’s not as involved as you may think to adopt more competitive savings products, even for a short-term benefit.

A marketplace for high-yield savings products like Raisin enables savers to choose from a wider variety of products offered by a wider selection of financial institutions. And a rising rate environment is a time when savers want, and should seek, out maximum choice.

Predicting what the Fed will do to interest rates, and when, is a popular pastime that leads to many wrong guesses. But the broad consensus is that in 2022 there are likely going to be multiple rate hikes succeeding the initial bump that was announced in mid-March.

So what to do with deeper cash reserves, i.e., money that can be put to work in a less liquid savings product?

Savers may well wonder if the rates available on certificates of deposit (CDs) will improve over the remainder of the year, leading some to forgo this product category — which restricts access to funds for a fixed term — under the assumption that more attractive rates are just over the horizon and therefore worth waiting for. Just remember, it remains to be seen how and to what extent banks will react, if at all, to potential changes to Fed rates, as seen in their deposit product offerings.

Savers in this predicament, where future rates are subject to change, are pondering what is known as reinvestment risk. (Interest rate FOMO, if you will.) But there are methods of deploying CDs that can help you earn pleasing returns while avoiding the Fear-Of-Missing-Out feeling that you passed on better rates.

The CD ladder. This savings strategy has you purchase CD products with equal funds in incrementally longer durations. Imagine splitting $4,000 into $1,000 parcels and buying four CDs at 1-, 2-, 3-, and 4-year terms; or at 3- 6-, 9-, and 12-month terms. This approach gives you regular access to a portion of your funds — i.e., on the CD maturity date — at which time you can reassess the interest rate environment.

You can roll the cash in the shortest-duration CD into a long-duration (and usually higher-earning) CD — i.e., buy a 4-year CD with the proceeds of the 1-year CD when it matures — and not affect the regularity of access to funds. This is one of the key benefits of a CD ladder.

The CD bullet. This is considered the inverse of the CD ladder strategy. Instead of dividing and parking a large sum across multiple CDs at once, the bullet strategy suggests putting a portion of your nest egg in a long-duration CD — say, a fifth of your funds in a 5-year term — and, after a year, buying a 4-year CD with another fifth of your cash reserves, and so on. In four years, you invest the last fifth of your funds in a 1-year CD. This way, all your CDs mature together, at the end of five years.

If you expect rates to continually rise over time, this allows you to take advantage of the upswing as it plays out. Savers sometimes employ the CD bullet if they have a big expense they’re saving for down the road, like college tuition.

The CD barbell. With the CD barbell strategy, savers split their nest egg into two larger parcels, and buy two CDs at a shorter and a longer duration, like two years and five years. This allows a saver to reconsider their outlook after two years and adjust how half their cash reserves are invested.

No-penalty CDs. This financial tool functions like a CD, in that it offers a fixed return over a set period of time. However, you can withdraw the funds in a no-penalty CD before the account matures without it costing you a penalty fee. This provides a nice balance between high yield and access. If you decide in the future you want to change up the composition of your savings portfolio, you can do so and not worry about fees chipping away at your returns.

Raisin lets you put your cash savings to work by giving you access to an exclusive network of banks, credit unions and savings products, including high-yield savings accounts, money market accounts, fixed-term CDs and no-penalty CDs — all through one, unified login. Explore savings products available through Raisin.

All participating financial institutions on the Raisin platform are federally insured, so you can rest easy knowing your deposits are protected up to the limits of federal law. And with Raisin, you don’t have to worry about charges eating into your savings — there are no fees to enroll.

As choice becomes increasingly important as interest rates tick up, Raisin can help give you the options to make the right calls when it comes to your savings — from an always-growing inventory of competitive products, to a diverse selection of financial institutions with missions that reflect your values.

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