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How to maximize your interest earnings following a Fed rate cut
For the second time this year, the Federal Reserve lowered the federal funds rate — and there may be more cuts next year.
Rate cuts can be cause for celebration, particularly if you're planning to buy a home or pay off debt. But you can also expect to earn less interest on bank deposits and some investments. In other words, now is a good time to reevaluate where you keep your savings and look for ways to maximize your interest earnings.
What happens when the Fed reduces its target rate?
Interest rate reductions have several implications when it comes to banking and borrowing money. Here's what you can expect after a rate cut from the Fed:
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Loans: If you have a fixed-rate loan, nothing will change. However, if you want to take out a new mortgage or car loan, for example, or refinance an existing loan, the annual percentage rates (APRs) offered by lenders will be lower. As a result, it's more affordable to borrow money since you’ll accrue less interest and monthly loan payments may be lower too.
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Bank accounts: The annual percentage yield (APY), or interest you earn on bank deposits, decreases. As a result, you'll earn less on the cash you keep in your checking and savings accounts.
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Low-risk investing: If you already have an investment account that gives you guaranteed returns, such as a certificate of deposit (CD) or Treasury bill, your rate will stay the same. However, the rates offered on new accounts will begin dropping.
Read more: What the Fed rate decision means for bank accounts, CDs, loans, and credit cards
How to maximize interest in light of falling rates
The upcoming Fed rate cut is expected to be conservative, so you may only see gradual changes to your interest rates in the short term. However, more cuts are likely to come, so now is a great time to lock in high rates and prepare your next steps.
Choose a high-interest bank account
For your day-to-day cash and emergency savings, it's best to keep the money in the bank, since you need to maintain easy, penalty-free access to your funds.
But as banks reduce the interest rates offered on deposit accounts (which they can do at any time), your balances will earn less. As a result, you'll want to check the APY on your bank accounts and shop around to see if you can earn a higher rate elsewhere. Here are some bank accounts that might earn more than your regular checking or savings:
Read more: How do banks set their savings account interest rates?
Open a CD now
When it comes to money you don't plan to use within the next few months, consider moving it out of your savings account and into a CD right away. By doing so, you could lock in up to 4.5% APY or higher before rates take another hit.
In addition to comparing rates, look for CD accounts with longer terms, since the goal is to retain your high rate long past any future rate cuts.
This strategy is particularly useful for anyone who's been saving for a down payment on a home. By moving your savings into a CD, you can lock in a high APY while waiting for mortgage rates to drop. If you're not exactly sure when you'll need your money, you might also consider CD laddering, or opening up multiple CDs with staggered maturity dates.
Lock in T-bill rates
Like CDs, Treasury bills are a good choice if you're saving up for a future expense and you want to lock in high rates before they start falling. At present, you can still get around 4.5% on several T-bill terms. However, the Fed's rate cut means these rates won't stay for long.
Before you buy a T-bill, compare the rates and terms with available CDs to see where you can maximize your earnings. And keep in mind that you don't have to pay state or local taxes on T-bill earnings.
Read more: CDs vs. Treasury bills: Maximizing your savings
Rebalance your long-term portfolio
As rates fall, you'll have to increase your risk in order to maintain or beat what you've been earning on cash deposits and fixed-income assets. That means that when your current CDs, T-bills, and bonds mature, you may want to move the money to your stock portfolio.
While rate cuts tend to be good for the stock market, it's too soon to tell how it will respond over the coming months. In other words, some patience is required. But while you're waiting to see how the market stabilizes, some experts suggest investing in stocks that are more sensitive to rate cuts, such as real estate investment trusts (REITs) and small caps.
Read more: High-yield savings account vs. investing: Which is right for you?
