Time to Jettison Your High Yield Savings Accounts?
High yield savings accounts were a refreshing blast from the past. That’s about to change.
If you take a trip, way, way back in the way-back machine, you’ll find that those of us old enough to remember were routinely getting 5.25% interest on our plain-vanilla passbook accounts at our local bank.
We didn’t have to jump through any hoops to get it either. Today, it takes some searching around on the internet to find reliable, FDIC-insured banks that offer this type of high yield interest.
Yesteryear, in days long gone by, it simply took a little stroll down the street to your local savings bank. You see, in the 1950’s and 1960’s, 5.25% interest on passbook savings accounts was mandated by the federal government. You didn’t need any special skills, finance knowledge, or internet know-how to track down a bank willing to pay this much interest. They all paid the same rate, 5.25%.
Well, Jerome Powell, the head of the Federal Reserve, gave us fair warning in a recent speech that economic conditions warranted an easier monetary policy going forward. In fact, most analysts concluded that a reduction in the Fed Funds rate was baked in for the September, 2024 meeting.
Catalysts for the Change
The Federal Reserve is charged with two major responsibilities.
Keeping unemployment down thru maximum employment
Price stability-keeping inflation in check
Recent Labor Department reports have shown unemployment rising from an extraordinarily low 4.3% to 5%. Though 5% has been traditionally, historically regarded as full employment, it is the upward trend of this metric that has caught the eye of the Fed and has made market-watchers wary.
Though a reduction in inflation has made steady progress over the past 10 months, it is still riding above the Fed’s preferred 2% target range.
The Golden Age is About to Transition to the Bronze Age
It’s been a golden era for high-yield savings accounts. But with interest rates set to come down, it is time for savers to look at other vehicles like CDs and Treasury notes that will let them lock in today’s yields for years to come. These can be used as hedges against declining rates to come.
Online savings accounts now paying interest rates of 5% or more are easy to set up and convenient to use, so it isn’t hard to see why investors love them. But with the Federal Reserve likely to cut interest rates as soon as September, online savers may soon face some hard choices. Markets got more insight into the Fed’s plans on Friday when Chair Jerome Powell addressed the central bank’s annual conference in Jackson Hole, Wyo.
Once the Fed does cut rates, most savers will see changes within a month if not sooner. Banks, seeking to maintain their profit margin will normally cut their rates in sync with the Fed, post haste. Some popular banks, including Ally and Marcus, have already started edging down rates, by ¼% each.
Lenders have reason to try to contain their costs, especially when long-term lending rates are comparatively low, putting pressure on banks’ profits.
Banks’ response will be a lot more rapid than when rates are rising. They are always quicker to reduce interest they pay when rates are declining.
All in all, investors should expect savings account rates to decline by about 2 percentage points over the next year, based on futures market forecasts for the benchmark federal-funds rate, which closely influences savings rates. That equates to about $200 in lost interest for every $10,000 invested. If you have $100,000 stowed away in these accounts, you’re looking at a $2000 reduction in annual income coming your way. Whatever amount you have in these accounts, multiply that amount by .02 (2.0%) to discover how much less annual income you’re about to receive.
Fortunately, there are a number of alternatives to high-yield savings accounts for anyone who wants to lock in today’s attractive APYs.
CD Laddering
Certificates of deposit offer interest rates that are just as good as top savings accounts, or better. Top yields today for a six-month CD are around 5.25%, according to the marketplace Bankrate.com. For a three-year CD, they are in the 4.5% to 5% range.
The tricky point is that while with CDs you can typically count on the interest rate for the length of the CD’s term, you typically aren’t allowed to touch your money until the term expires. It is a trade-off of flexibility for certainty. You can, however, with most banks, request monthly interest be deposited into your checking account if you need funds to pay your bills. It is the principal amount in the CD that is untouchable, save with penalties if you withdraw principal early, before maturity.
You can make an end-run around this restriction by building a CD ladder, investing a portion of your cash in various CDs with different terms. For instance, if you had $25,000 in cash to invest, you might put $5,000 in a six-month CD, $5,000 in a one-year CD, $5,000 in an 18-month CD, and so on. When the six-month CD expired, you would buy a new one with an expiration date six months beyond your longest-dated holding, unless you needed the money right away.
CD ladders aren’t a full-proof solution. You will still pay a penalty if you need all your money for a big emergency. But they can provide protection against rising rates, while ensuring you regular access to at least some of your cash.
No-Penalty CDs
Another option is no-penalty CDs, which allow investors to lock in today’s interest rates without CDs’ typical downside: the charge investors who want their money back early have to pay. Of course, there is no free lunch. These CDs typically offer lower interest rates than similar products that lock your savings away. This is a trade-off. Let me repeat: There’s never a free lunch.
Still, investors don’t necessarily sacrifice much, and it may be well worth it for the extra flexibility. Marcus, for instance, offers an 11-month no-penalty CD with an 4.7% APY, just a hair below the 4.8% on its standard 12-month CD. Both rates are 30 to 40 basis points better than the 4.4% it pays on savings accounts.
There are some additional caveats to be aware of. Not all banks offer no-penalty CDs. Those that do may offer only a single term, such as 11 months, so you can’t necessarily use these to build a CD ladder.
And, while you can get your money early, these aren’t as flexible as savings accounts, which allow you to make partial withdrawals. If you do make an early withdrawal, you have to close the CD. You take all principal and all interest. It’s all or nothing.
Treasury Notes and Bills
You don’t necessarily have to rely on banks to safeguard your savings. You can also turn to the Federal Government. You’re used to hearing in the financial press how the nation’s debt is constantly rising. Agencies of the government are always in need of money and are constantly floating new debt issues. They want your money. After all, if it’s good enough for Warren Buffett, one of the world’s largest owners of Treasury bills, it must be good for the rest of us.
Today, six-month Treasury bills yield 4.9%, while two-year Treasury notes, which will allow you to hang on to today’s rates for longer, yield about 3.9%. Investors can buy them through a brokerage account or from the government’s Treasury Direct website.
While yields are slightly below what you can expect from a CD or savings account, Treasury notes have some other advantages. If you need the money sooner than you expect, you can sell your Treasury note to another investor. (If you bought the note through TreasuryDirect, you need to transfer the security to a bank or brokerage first.)
Of course, when you sell you might not get the same price you paid to buy the note. But today’s investors face little risk on this front, given most investors expect rates to fall. Bond prices move in the opposite direction to interest rates, so if you do end up selling, there is a good chance it will be at a premium and you’ll have a nice capital gain.
Treasuries also enjoy some tax advantages over other savings instruments. Interest income is exempt from state and local taxes. Investors living in high-tax states like New York or California, for instance, will save around 6% or more in taxes not payable on these securities, depending upon their actual tax bracket.
Bottom Line
We are on the cusp of an important change in monetary policy, going from a tight, constrictive high-rate environment to a looser, easier monetary regimen which will see interest rates trending down. The Fed’s aim is to keep the economy humming, bolster employment and keep inflation in check.
While the easy money in high-yield savings accounts has been made, experienced investors know that now is the time to begin planning for the next monetary cycle. Rolling with these cycles and adjusting as they occur gives investors the opportunity to lock in higher yields with alternative investments now. Wait too long, and the opportunities vanish.
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the author
George Schneider
Founder and publisher
Retirement: One Dividend At A Time
Disclaimer: This article is intended to provide information to interested parties. As I have no knowledge of individual investor circumstances, goals, and/or portfolio concentration or diversification, readers are expected to complete their own due diligence before purchasing any stocks mentioned or recommended.
Disclosure: I am long all RODAT Portfolio names. The Portfolio continues to build dividend income with reliable, dependable equities which have long histories of increasing the dividend.