For borrowers, that means the cost of buying a home or carrying a balance on a credit card will soon get even more expensive. But there’s a silver lining for savers: higher federal interest rates can lead to more interest earned on your savings balance.
The Federal Open Market Committee this week increased its target range for the federal funds rate from 0.75-1% to 1.5-1.75%. That’s three quarters of a percent jump from the rate set in May, and the largest single increase since 1994.
It’s also the third interest rate hike this year. The Fed began raising interest rates in March to offset this year’s record inflation numbers. Previously, interest rates held at near-zero since the start of the pandemic.
Here’s more about what the Fed’s decision means for your savings interest rate, and how to balance this year’s increasing rates:
What the Fed’s Interest Rate Hikes Means for Savers
When the Federal Reserve raises its target federal funds rate, banks tend to follow suit.
“It’s not as closely tied as people think,” says Sophia Bera Daigle, CFP and founder of financial planning firm Gen Y Planning — meaning you’re not likely to see an immediate increase by 0.75% interest on your savings. But in general, rates on deposit accounts like savings accounts, money market accounts, and CDs are expected to increase
“Banks do this to attract more customers who will provide more cash flow for banks to leverage,” says Delyanne Barros, money expert and founder of Delyanne the Money Coach.
Still, while it’s likely many banks will raise rates, you can expect some banks to increase APYs faster and by a greater amount than others. For example, large, national brick-and-mortar banks with traditional savings accounts may only increase their interest rates minimally, if at all. Many of these banks simply aren’t in a big rush to raise APYs right now, Barros says.
“This is why it’s important to shop around for a high yield savings account and not necessarily use the one offered at the bank where you keep your checking,” Bera Daigle says.
How Much Will Savings Interest Rates Increase?
The largest rate increases are more likely to appear from online banks that offer high yield savings accounts. The best rates among these accounts already offer more than 10x the national average interest rate, and have historically been the first to raise their APYs after the Fed increases its target range.
Today the best high-yield savings interest rates range from 0.70% to upwards of 1% APY.
“Before the pandemic, some online banks were paying 2% to 3% in interest,” Barros says. “It’s hard to say if we’ll see those numbers again this year, but it’s possible they may return eventually if the Fed continues to raise interest rates and inflation isn’t tempered. Banks may also be motivated to raise interest rates since they are also competing with I Bonds this year, which have attracted many savers.”
Why Now Is a Good Time to Save
In its release Wednesday, the Fed cited “elevated” inflation exacerbated by the war in Ukraine, COVID-related lockdowns in China, and other supply chain and price pressures and the major factor in its decision. That’s following ongoing talk among experts about a bear market for stocks and potential looming recession.
As inflation continues to hit record highs and Americans take on higher debt balances, it’s a great time to begin shoring up your emergency fund or revisiting the amount you have saved.
In general, experts recommend keeping at least three to six months worth of expenses in an emergency fund in an accessible high yield savings account. Only you can determine the amount you’re most comfortable with though, based on your monthly expenses, how secure your income is, any dependents you may have, and other individual factors.
“It’s always a good idea to have an emergency fund saved regardless of what’s going on in the economy,” Barros says. She recommends three to six months as a general goal, but says it can be wise to bump that up to nine months if you’re at higher risk of losing income in a recession. “Remember that this is to cover your most necessary expenses, not every expense you currently have, so take the time to decide what those are and set a savings goal.”
But after you’ve saved your emergency fund, don’t let fear lead to you hoard all your extra cash in your bank account.
Even in times of uncertainty, it’s a good idea to continue investing for long-term goals like retirement in a diversified investment portfolio. If you have cash on hand and a secure emergency fund, Bera Daigle recommends setting up automatic contributions to a brokerage account and maxing out your IRA or Roth IRA.
“Once the emergency fund is saved, then I highly recommend continuing to invest even during a bear market,” Barros agrees. “The best thing to do is to dollar cost average and be patient. The best way to balance saving and investing is by setting up automatic transfers to your accounts so you can remove any emotions like fear or anxiety out of these decisions.”