How to Maximize Your Savings When Interest Rates Are Rising
When the U.S. economy is showing signs of improvement, the Federal Reserve may opt to raise interest rates.
The result is that borrowing rates increase, but savings rates also increase.
The interest rates on savings accounts at big banks might not move much.
The top online savings rates are likely to rise.
The main concerns now are, “When is the rate hike coming and how should I prepare for it?”
By getting answers now and planning your strategies before the inevitable rise in interest rates, you’ll be better prepared to move your money into savings vehicles that will keep pace with rising interest rates and inflation.
Head to Online Banks for Bigger Savings
We get your savings concerns. You don't like low savings rates.
Meanwhile, you don’t want to be trapped with low CD rates when interest rates actually start to rise.
Instead, open an online savings account, which tend to offer the highest rates available nationwide.
Again, when rates do rise, savings rates at big banks will continue to pail in comparison to online banks. And, since savings rates move with the market, you're always going to be earning better-than-average interest returns with an online savings account.
Sure, even with the high savings rates offered by online banks, the interest earnings may struggle to keep up with inflation right now.
But, it is better than nothing. Right?
Don’t let your money sit there earning pennies of interest -- or even worse, nothing at all.
Open Certificates of Deposit (CDs) Without Fear
Interest-rate risk is a valid concern whenever CDs are involved.
Since you’re locking your money at a certain rate for an extended period of time, you’re afraid that you’ll miss out on higher rates when rates begin to rise.
Therefore, go right ahead and open the CD with highest rate available now.
It’s much better than letting your money sit around doing nothing.
Compare CD rates to help you with that decision.
If you are truly wary about significant rate hikes, you should open a bump-up CD.
This type of CD usually offers one rate-increase -- to be used you believe that the market rate is significantly higher.
One great strategy is to build a CD ladder, which help you earn high rates without locking yourself out of too much of your money.
Why Rates Rise
Typically, rates tend to rise as the economy heats up.
In an improving or expanding economy as demand increases for dollars, materials, labor, etc., their value and prices ride up as well.
Interest rates, of course, don’t fall (or rise) by themselves.
As part of its mandate, the Federal Reserve largely controls short-term interest rates.
Short-term interest rates are loan contracts or debt instruments such as Treasury bills, bank certificates of deposits (CDs) and commercial paper having maturities of less than a year.
These are often called money market rates.
By contrast, longer term rates are interest rates on financial instruments with a maturity longer than a year, such as a 15-year or 30-year mortgage.
Note: Long-term interest rates are largely controlled by the bond market.
Strategies to Score Rising Rates
If you believe at all in the supposition that interest rates could be headed upward, then you owe it to yourself to develop a strategy for this potential rising-rate environment.
Here are the steps we recommend:
1. Know the kind of investor you are
First, if you’re uncomfortable with the daily gyrations of the stock market, where your net worth could just as easily fall as rise on the fortunes of a stock:
Keep your money in a savings vehicle.
Similarly, if you’re uneasy about investing in bonds, whose prices as a rule fall when interest rates rise:
Stick with a CD or other savings instrument.
2. Stay a little bit liquid
Liquid money is money that you can easily access from your checking or savings account.
This is money you can’t afford to have tied up.
Although you lose yield, you gain flexibility and access to move your money quickly in a rising-rate environment.
3. Think short-term
It’s easy to “chase yield,” which means investing in whatever savings instrument offers the highest yield on the day you visit your bank, in person or online.
But, you might feel pretty foolish locking up that 2.5 percent CD for five years if interest rates suddenly spike to 3.5 or 4 percent.
So, stay shorter term with perhaps a 1-year or 3-year CD.
4. Make the bank share your risk
One way to make your bank shares your risk:
Take out a variable-rate CD.
A variable-rate CD is one in which the interest rate changes during the product’s term.
If interest rates rise, the CD’s interest rate will rise as well.
Unfortunately, rates could also fall, and the value of your CD right along with it.
Most banks, however, offer a guaranteed return on principal for variable-rate CDs (when held to maturity), which protects customers from actually losing money in a down market.
5. Construct a CD ladder
With stocks, some investors dollar-cost average, a technique of buying a fixed-dollar amount of a particular investment on a regular schedule, regardless of the share price.
More shares are purchased when prices are low, and fewer shares are bought when prices are high.
Building a CD ladder is somewhat similar because you also follow a schedule.
You might put $2,000 in a three-month CD, another $2,000 in a six-month CD; $2,000 in a nine-month CD; and the final $2,000 in a 12-month CD.
This way, you spread your risk.
6. Our final TIPS
TIPs stand for Treasury Inflation-Protected Securities.
Savers who seek protection from inflation, which is usually accompanied by rising interest rates, may want to invest in this hedge instrument.
The way they work is your principal increases if inflation rises and your principal decreases if deflation occurs.
At maturity, you receive the adjusted principal or the original principal, whichever is greater, so, in a worst-case scenario, your original investment is always protected.
IPS are sold at auction four times a year in $100 allotments, or can be purchased on the secondary market at any time through banks and brokers.
Again, don’t let the fear of rate hikes deter you from saving now.
Firstly, get that online savings account to maximize the interest return on your free cash. If do nothing else, at least do that.
If you want to earn a little more interest, open a CD without too much fear of rate hikes when you use the mentioned strategy to ensure that you're earning the highest CD rates at all times.