The rate hikes make new debt, as well as older debt that carries a variable interest rate, more expensive — but the silver lining is that higher rates also benefit savers.
“Interest rate hikes are a bit of a double-edged sword,” says Jennifer Raess, CFP®, Advice Integration Lead at Northwestern Mutual. “Yes, higher interest rates make borrowing money more expensive. But they can also increase the yield you earn on your savings, which is something we haven’t seen in quite some time.”
That’s what makes this a good time to reassess your personal savings. Raess recommends reviewing your personal financial situation and goals, and then asking yourself some specific questions to determine which savings vehicles may be right for you.
Questions to ask before choosing a savings vehicle
How soon will you need the money?
The more time you have until you need to access your money, the more options you have. That’s because certain savings vehicles (like certificates of deposit, or CDs) require you to “lock” your money away for a period of time. Withdrawing funds from these accounts early can result in fees or forfeited interest.
Raess says the closer you are to needing the money, the more liquid your savings should be — even if that means you may need to forgo a higher interest rate.
“For example, you should keep the money you are saving for a short-term goal — such as a wedding or a planned vacation —in an account that’s accessible,” Raess says. “The same holds true for your emergency fund. When an emergency arises, you want to be able to get that money without worrying about fees, penalties or taxes.”
But once you have the financial basics covered, Raess says you can consider investing your money because “you're going to get more growth potential in accounts that take on a little more risk, and where you're putting money aside for a longer period of time.”
What are the tax implications?
Before putting your savings to work, Raess recommends that you consider the tax implications of each option. Ask yourself:
- How will this savings vehicle impact my tax bill?
- How will taxes affect my rate of return?
- Is there a more tax-efficient option that I’m overlooking?
“This is especially important when you start moving into the world of investing, where you have the potential for dividends, interest and capital gains,” Raess says. “All of these can have a big impact on your tax bill.”
The good news is that if you are saving for specific types of goals (retirement or college, for instance) there are many tax-advantaged accounts — including a traditional or Roth IRA, 401(k) or 529 college savings account — that you might be able to leverage to reduce the impact of taxes.
How will it impact your budget?
Raess notes that some accounts require you to have a minimum balance to open an account, avoid fees and/or earn a higher interest rate. If you don’t have the room in your budget to account for these requirements, then you may want to consider other options.
Options for getting a potentially better rate on your savings
1. High-yield savings accounts
A high-yield savings account is exactly what it sounds like: A savings account that offers a higher interest rate compared to most standard savings accounts — often, as much as 10 to 20 times higher.
How is that possible? Usually, these savings accounts are offered by digital banks that don’t have brick-and-mortar branches. This reduces their expenses, allowing them to offer higher interest rates to their customers.
“They’re a good option for your short-term savings goals,” Raess says, “including your emergency fund. Just keep in mind sometimes these come with minimum balance requirements to get the higher interest rate.”
2. Money market accounts (MMAs)
A money market account typically carries some features found in a checking account, such as the ability to write checks or withdraw funds using a debit card, but at interest rates comparable to a high-yield savings account.
“Like high-yield savings accounts, money market accounts can be a good place to park money that you expect to need in the short term,” Raess says. “Just be aware of how much money you need to open and maintain the account.” An investment in a money market fund is not insured or guaranteed by the FDIC or any government agency.
3. Certificates of deposit (CDs)
A CD is another type of savings vehicle offered by banks. With a CD, you agree to deposit your savings for a set period of time. In exchange, your money grows at an interest rate that is higher than what you’d typically receive from a savings account.
How long it takes for a CD to mature is called its term. Common terms include 1-month, 3-month, 1-year, 3-year and 5-year CDs. Generally, the longer the term, the higher the interest rate will be.
The downside? If you need to withdraw your money ahead of schedule, you’ll pay a fee — typically, in the form of forfeited interest.
“For this reason, CDs can be a great option when you know for certain that you won’t need your savings for a certain period of time,” Raess says. “But they’re less optimal for something like general savings or your emergency fund, where you never really know when you’ll need your money.”
4. U.S. savings bonds
Savings bonds offered by the United States Treasury are backed by the full faith and credit of the federal government, which means the risk of losing your principal is extremely low.
Currently, the Treasury offers two types of savings bonds: Series EE bonds earn a set amount of interest each year but are guaranteed to double in value after being held for 20 years, while series I bonds have interest rates pegged to inflation.
“Bonds are generally considered to be more suitable for someone who’s more risk-averse, because the principal is virtually guaranteed,” Raess says. “And depending on the type that you buy and how long you hold them for, they can be an effective means of combating inflation.”
Both EE bonds and I bonds are better suited for mid- to long-term savings goals. You can earn interest on them for up to 30 years, although you can cash them out after one year. But if you cash them out before the five-year mark, you’ll forfeit the last three months’ worth of interest.
Of course, it’s important to look at bonds as part of a comprehensive financial plan and make sure you’re balancing risk and reward (more on that below).
5. Investing in a balanced portfolio
If you’re saving for a goal that’s 10 or more years away, you could potentially earn more of a return on your money by investing it in a balanced and well-diversified portfolio designed for your unique risk tolerance and time horizon.
“Investing is best suited for longer-term goals such as saving for retirement or a child’s education,” Raess says. “You’ve got time to ride out market volatility, recover from losses, and generally earn a higher rate of return on your money over the long term than other savings options.” The potential for a higher rate of return does involve risks so it’s important to consider those when making a plan.
If you’re feeling overwhelmed by the many savings vehicle options available, work with a financial advisor to establish a timeline for your savings as part of a personalized financial plan. How you save and grow your money should be taken into the context of your goals and your bigger financial picture.
Information is provided for educational purposes only and is not a recommendation for any particular investment. All investments carry some level of risk including the potential loss of all money invested. No investment strategy can guarantee a profit or protect against loss.
This article is for informational and educational purposes only and should not be interpreted as financial or investment advice. Northwestern Mutual Financial Representatives cannot sell or recommend the purchase of I bonds.
You should carefully consider risks with fixed income securities such as bonds. These include: Interest rate, Duration, Credit, Default, Liquidity and Inflation.
Certified Financial Planner Board of Standards Inc. owns the certification marks CFP®, CERTIFIED FINANCIAL PLANNER™ and CFP® (with flame design) in the U.S., which it awards to individuals who successfully complete CFP Board's initial and ongoing certification requirements.