In terms of Federal Reserve rate hikes, 2018 will likely be similar to 2017, and that should be helpful to your cash holdings as many banks respond to the Fed rate hikes. Since the Fed started its tightening policy, it has hiked rates twice in the 13 months before 2017 and three times in 2017.
Overall, deposit rates have responded slowly. The average savings account rate as tracked by DepositAccounts.com has risen only from 0.180 percent to 0.193 percent, an increase of only about 7 percent. Not all banks have responded this slowly. With a little work, you can get a much higher interest rate on your cash holdings than this average.
Internet savings accounts. The saving account average rate of 0.193 percent is dominated by brick-and-mortar banks and credit unions, which have been in no hurry to raise their deposit rates. Internet banks have been different. An analysis of the savings accounts from 10 large internet banks determined that the average savings account yield in 2017 increased from 1 percent to 1.33 percent.
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The first important thing to note is that the average internet savings account rate at the start of 2017 was more than five times the rate of the brick-and-mortar average. Even before the first Fed rate hike in 2015, it was easy to obtain yields close to 1 percent on internet savings accounts. Without the overhead of branches, internet banks have always been able to offer much higher interest rates than traditional banks.
The second important thing to note about the average internet bank yield in 2017 is that it increased 33 percent. The increase was less than the federal funds rate increase in 2017, but it was much more than the increase of the brick-and-mortar savings account average of 7 percent. Based on the history of the last Fed tightening cycle from 2004 to 2006, the rate increases at internet banks should accelerate and approach the increases of the federal fund rate. Thus, if the federal funds rate rises 75 basis points in 2018 as it did in 2017, internet savings account rate increases will likely be closer to 75 basis points than 33 basis points.
The main tip from this analysis is that you should be holding most of your cash at internet banks instead of brick-and-mortar banks. This is the easiest way to get a higher return on your cash. This doesn’t require you to close your brick-and-mortar accounts. Internet banks make it easy for you to link your existing checking account to their internet savings account. Once linked, you can electronically transfer money between your brick-and-mortar checking account and your internet savings account. In terms of safety, the internet banks are just as safe as the brick-and-mortar banks with the same FDIC deposit insurance.
Money market funds. Internet savings accounts aren’t the only game in town. A money market fund is another option for your cash that can offer comparable yields to internet savings accounts. First, a money market fund isn’t a deposit account and should not be confused with a money market account. Money market accounts are essentially the same thing as savings accounts. Both are deposit accounts that are offered by banks and credit unions. The deposit accounts are federally insured (by the FDIC for banks).
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Money market funds are a type of mutual fund that invests in high quality, short-term debt securities.They are available at brokerages and are not FDIC insured, but they are generally considered to be low-risk investments.
If you have investments at a brokerage, a money market fund is a useful place to park your cash. An important feature of money market funds is that their yields tend to be directly impacted by federal funds rate changes. As the federal funds rate has increased since 2015, money market fund yields have also increased at similar levels. For several years before 2015, most money market fund yields were 0.01 percent, just a tad above zero. During this time, internet savings accounts were the clear winner for your cash. Their yields never dropped much below 1.00 percent. After the five Fed rate hikes, it’s possible to obtain a money market fund yield that’s close to the yields of internet savings accounts.
One advantage of money market funds is that there are tax-exempt versions. These invest in tax-exempt municipal securities. The yields of these tend to be lower than the taxable money market funds, but the after-tax yield for those in high tax brackets can be much higher. Muni money market funds now offer after-tax yields higher than internet savings accounts for those in high tax brackets.
Bottom line. Internet savings accounts currently offer higher yield and more safety than money mar funds, but money market fund yields have recently become competitive and they should remain competitive as the Fed continues to hike rates.
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A downside with internet savings accounts is that you are dependent on the bank remaining competitive. A change in deposit needs can cause an internet bank to fall behind on its rates. That’s why you can’t be complacent with your internet savings account. Make sure to monitor the rates to ensure your bank is keeping the savings account competitive.
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Tips on Where To Get a Better Rate for Your Money originally appeared on usnews.com
