The Advantages of a Rising Interest Rate Environment

The news is full of negative headlines these days about the rising interest rate environment.  The Fed Funds rate (i.e. the interest rate that the Federal Reserve establishes for overnight loans among banks) has jumped 3 percentage points in the last year, reaching levels that we haven’t seen since before the Great Recession.  Many are concerned that this move may lead to another recession.  It has driven down the price of bond funds, hurting even the more conservative side of investor portfolios.  And it negatively impacts borrowers looking to obtain a new mortgage or car loan, or those who have debt with variable interest rates like a home equity line of credit or credit card debt. 

However, there is another side of the rising interest rate coin.  After a 14-year stretch with short-term interest rates below 3 percent—with rates actually hovering near zero for 10 of those 14 years– we can finally start earning some interest on our cash.  While savings accounts at most of the major commercial banks (e.g. Wells Fargo, Bank of America, PNC Bank) are still offering a measly interest rate of 0.01 percent, high yield savings accounts, CDs, money market funds, and short-term Treasury bonds all provide safe and relatively easy ways of earning more significant interest on your savings.

High Yield Savings Accounts.  There are a number of online banks offering savings accounts with more compelling interest rates than those mentioned above.  We have PFS staff and clients, who use, e.g., Capital One 360, Ally Bank, Discover, and Synchrony Bank, which are currently offering between 2.25% and 2.45% interest on their high yield savings accounts.  These high yield savings accounts have no minimum balance requirements, are FDIC insured, and typically allow you to transfer funds to or from your checking account in 2-3 business days.  In terms of liquidity, flexibility, and protection, this is a very easy and safe way to earn money on your cash.

Certificates of Deposit (CDs).  Many of the online banks also offer CDs with more competitive rates than the major commercial banks as well.  The ones mentioned above are currently offering 1-year CDs paying 3.25% interest or more.  Through a brokerage like TD Ameritrade, the rates could be even higher.  (TD Ameritrade currently offers access to 1-year CDs paying more than 4%.)  The CDs are FDIC insured, and the online bank CDs generally have no minimum deposit, but you do incur a small penalty if you need to withdraw funds prior to the end of the term.  The higher rate (as compared with high yield savings accounts) aims to compensate savers for this decrease in flexibility, as well as for the risk that short-term interest rates continue to rise such that savings accounts could be earning more in interest than the CD by the end of its term.

Money Market Mutual Funds.  Another option if you have an investment account (e.g. a taxable account at TD Ameritrade or another brokerage) is to use your cash to purchase shares of a money market mutual fund.  Money market mutual funds invest in very short-term debt and other government and corporate obligations, so they are extremely low risk and the price of the funds is very stable (generally the price of shares is pegged to $1).  Many of these funds are offering higher yield than online savings account for a negligible increase in risk.  For example, Schwab offers a variety of money market mutual funds with yields currently ranging from 2.65% to 2.92%.  Most of these funds have no minimum investment, no trade fees for buying and selling shares, and no minimum timeframe for which they need to be held, but they are not FDIC insured like the bank products mentioned above.

Short-Term Treasury Bills.  A final option for taking advantage of rising interest rates is to use your cash savings to buy short-term Treasury bills (T-bills).  The yield on short-term Treasuries (less than 1 year) is over 4%, and like the money market mutual funds, they can be purchased in an investment account through a bank or brokerage (like TD Ameritrade) or through the Treasury Direct website if you are planning to hold them until maturity.  Also like the money market mutual funds, T-bills are not FDIC insured, but they are backed with the full faith and credit of the U.S. government, so it’s a very safe bet that you will receive the interest that you are promised.  There is only a $100 minimum investment for buying T-bills, and their interest payment are exempt from state income taxes.  T-bills do face the same risk as CDs, however, that current interest rates could rise above the promised yield before the T-bills mature. 

If you have questions about which option might be best for you, please feel free to call or email us any time so that we can help you to enjoy the plus side of the current rising interest rate environment!