In today’s environment of low interest rates, there is less incentive to save. For every $10,000 you keep in a standard savings account, you’re likely to earn less than $10 in interest per year. With a certificate of deposit, you won’t be earning much more.
Savers aren’t reaping significant rewards for their financial behaviors due to the Federal Reserve’s suppression of interest rates. The central bank revealed it would begin to raise interest rates when the unemployment rate falls to 6.5 percent, according to the Bureau of Labor Statistics. Since the recession ended, the job market has improved gradually and currently stands at about a 7.6 percent unemployment rate.
Previously, Americans didn’t know whether it was a good decision to lock in money in a five-year CD or to simply keep it in a liquid savings account. Some consumers were rather unsettled by the fact committing to a long-term CD could mean their money gets stuck at a lower rate if interest rates increase. There was also fear among investors they’d miss an opportunity to secure a good CD rate if interest rates fell.
Here’s what you need to know about savings accounts and CDs in relation to the unemployment rate:
Savings accounts. As the unemployment rate drops, it’s likely banks – especially online financial institutions – will prepare to boost their savings rates. In the past, competition has led banks to battle as they attempted to surpass each other’s deposit rates. Similar combat is expected to take place when the Fed announces interest rate hikes.
Those who have resorted to riskier assets to chase higher returns (while savings rates were extremely low) can become more conservative without their savings earning pennies in interest.
If you’re the type to switch banks in search of the highest rate available, keep in mind there’s a strong likelihood there will be a different bank with the highest savings rate each week. Therefore, rate-chasing is worth it only if you tend to keep a sizable balance in savings.
Without a large amount of savings, the difference between a competitive rate and the best rate is nominal. It would be best to stick with an online bank that consistently offers competitive interest rates as opposed to the online bank that offers the highest interest rate.
CDs. Once the unemployment rate approaches the Fed’s target, locking money into any long-term CD may be a bad money move since CD rates are likely to rise – and you don’t want to be stuck with a low CD rate for years when interest rates are rising.
Instead, consider investing in short-term CDs – preferably those with zero or low early withdrawal penalties. In the event interest rates rise dramatically,you can withdraw the money from the CD without a lot of interest lost.
Another option is to go with a bump-up CD that let’s you increase the rate for the remainder of the investment’s duration without incurring an early withdrawal penalties.
Finally, you can build a CD ladder, which involves staggering your investments. To start off, you put money in one-, two-, three -, four- and five-year CDs all at once. As each CD expires, you renew into a new five-year CD. This strategy enables you to earn a competitive CD rate whether interest rates are rising or falling
Simon Zhen is a columnist and staff writer for MyBankTracker.com, where he covers banking, financial technology and savings rates.