Savings account interest rates are starting to show signs of life.
Yields are still low today – even many of the best high yield savings accounts are still below 1% APY. But as the Federal Reserve fights inflation and continues to raise its target federal funds rate, rates on lending products like mortgages and credit cards are rising. For borrowers, this means these products are only getting more expensive.
But there is a silver lining for savers. The interest you earn on money you keep in deposit products, including savings accounts, also increases. Interest rates on some savings accounts could reach 2% by the end of the year, according to an expert’s prediction.
Here’s what to know about rising interest rates and what to expect in the future:
Will savings account rates increase in the future?
Some banks have already started raising savings APYs, a trend that experts say will continue in the near future.
“The interest rates that consumers can get on a savings account…will increase as the Federal Reserve continues to raise the target federal funds interest rate,” says Kenneth Chavis IV, senior wealth manager at LourdMurray, a California-based wealth management group.
However, rates will rise at varying speeds and you won’t necessarily see an increase at all banks, according to Greg McBride, CFA, chief financial analyst at Bankrate. Like NextAdvisor, Bankrate is owned by Red Ventures.
“Right now it’s a perfect example of that,” he says. “We see online banks already in an arms race to raise rates on CDs, savings accounts and money market deposit accounts.” Local banks have also been at the forefront.
How quickly your bank is currently raising savings account rates is the best indicator of future rate competitiveness.
But experts expect even more momentum. As banks roll out these higher yields, they will automatically increase rates for existing customers. You can ensure you’re maximizing the income from your short-term savings or emergency fund by choosing a competitive high-yield savings account today.
“Where you have your money is going to be very important over the next two years,” McBride says. “At the rate at which interest rates are rising, some savings accounts will earn 2% at the end of the year; some will gain 0.02% at the end of the year. Which of those you have your money in is entirely up to you.
What factors influence prices?
Deposit account APYs don’t always follow Fed rate changes immediately — and Chavis predicts savings account rates, as well as money market account rates and CD rates, won’t move as aggressively as the Fed’s target range this year.
But competitive savings rates tend to track the federal funds rate in general and will continue to rise steadily as the Fed raises its benchmark interest rate.
One of the main influences on rising rates is the current high inflation, which is fueled by everything from supply chain shortages to the war in Ukraine. Inflation has a big impact on the Fed’s decision to raise interest rates, which, in turn, affects the market interest rates offered by financial institutions.
“What the Federal Reserve is trying to do is slow the economy in an effort to lower inflation, and the way it does that…raises benchmark short-term interest rates” , explains McBride. “Like dropping a rock into a pond, which ripples in all directions.”
When the Federal Reserve raises its benchmark interest rate, it drives up interest rates on everything from government bond yields to credit card lending rates. As the cost of money increases, consumers are also seeing higher payouts in savings accounts.
What is the federal funds rate?
The federal funds rate is the Federal Reserve’s main benchmark interest rate that banks use to charge overnight loans to maintain a minimum balance in their accounts, as required by the Fed.
When the Fed changes the target federal funds rate, it can affect everything from mortgage rates to savings account yields and credit card interest.
Rates have hit historic lows since the start of the pandemic as the Fed kept its target rate close to zero. “It worked really well,” McBride says. “We have seen very lively financial markets [and] rebound in economic activity. Employment rebounded very strongly. Unfortunately, inflation has also rebounded very strongly.
Over the past few months, the Fed has steadily begun to increase its federal funds target range. More recently, the Fed raised its target rate by half a percentage point (in a range of 0.75 to 1.00%) – the biggest increase since 2000.
The Fed is expected to continue with rate hikes, and fairly quickly – economists at JP Morgan, for example, have forecast nine rate hikes this year.
Will higher interest rates affect savings accounts?
As interest rates rise, savings accounts should follow. Some accounts are already increasing APYs.
When interest rates rise, banks tend to start raising rates on savings accounts to attract new customers. This, in turn, creates a competitive environment, prompting more banks and financial institutions to follow.
“When savings accounts and CD rates are higher, more people are more likely to keep maybe a little more money in their savings account or put something on the CD,” says chavis. “[This] ultimately slows or reduces the amount of money flowing through the economy, which is what the Fed wants.
However, not all banks have the same motivation to encourage customers to save more with higher rates. In fact, the national average interest rate on savings is still just 0.07%, according to the Federal Deposit Insurance Corporation (FDIC). Higher-yielding savings accounts with some of the most competitive rates available today – some even over 1% APY – usually come from online banks, credit unions, or local banks.
Savings accounts vs investment
Even in a high rate environment, you won’t get the same return from savings accounts as when you invest your money.
Among high-yield savings accounts, many of the best APYs are currently between 0.60% and 0.80%. The average historical return of the S&P 500, on the other hand, is around 10%. And given that the inflation rate was 8.3% in April, it’s safe to say that consumers are losing money by keeping it in a savings account.
However, savings accounts still play a key role in your financial portfolio.
Experts agree on the benefits of an emergency fund with at least three to six months of expenses. Your emergency savings should be highly liquid and protected from the risk of market fluctuations. That’s why it’s a good idea to keep this money in an FDIC-insured savings account. Having this insurance means that the funds will be safe even if the bank fails.
“Rate is really a secondary consideration, because what you need most of all with your emergency fund is access,” McBride says. “We need to be able to get the money anytime, when it’s needed.”
When it comes to money for longer-term goals, like retirement, it’s wise to invest it in a diversified portfolio of index funds or ETFs rather than keeping it in a savings account where it will not bear fruit as much. You will take on more risk and experience high market volatility in the short term, but in exchange, you can earn much higher returns on these long-term investments.