Maximizing Interest On Savings Remains Important In a Low Rate Environment

We’ve seen an incredible fall in interest rates over the last 12 months.

Bowing to political pressure, Fed Chair Jerome Powell began cutting interest rates on August 1, 2019 from a target rate of 2.25% to 2.50% and continued cutting rates by 25 basis points two more times in 2019 as a result of Presidential harassment.

At the beginning of 2020, the Fed funds target rate stood at 1.50% to 1.75%. Then, when the virus hit US shores, the Fed quickly moved to a zero to 0.25% Fed funds target in order to provide stimulus to the market.

In the months that followed, savings rates and short-term CD rates have tumbled. They may actually have further to fall. In fact, many leading online banks are offering CD rates well below their savings rates, providing a clear signal that they intend to bring savings rates down still further.

I am still getting a lot of emails from readers like the following: “I am in my 60s and I cannot stomach the market. I’ve taken $2 million out of the market and because I cannot find an online bank offering more than 1%, I’ve opted just to keep in at Morgan Stanley where I am getting 0.10%”.

Here is why this strategy is wrong.

First, if you look at the value of compounding, it is important that your cash always be earning as much as it can make. I think it is worth the effort to get an extra $18,000 in interest over the next year, even if you are in a higher tax bracket by locking into 1-year CDs that only pay 1% as long as you don’t need the cash. And, of course, if you do not need the cash until years out, earning 1% now looks even better over time. BestCashCow’s compounding interest calculator can help you further understand the importance of earning as much on your cash as you can over time.

Second, we have inflation in this country, although the virus may ultimately lead to price deflation. One goal with cash in savings accounts and short-term CDs is to maintain your purchasing power. Just this morning, the Consumer Price Index for all Urban Consumers (CPI-U) data recorded a 0.6% increase in food prices from June 2019 to June 2020. For people like the reader who wrote me above, an extra $18,000 a year in income, even if it is pretax income, will help to maintain purchasing power parity for their $2 million base in retirement.

Compare online savings rates here.

See the best online one-year CD rates here.