How savers should deal with declining interest rates

The interest rate environment has changed this year, leaving savers scrambling to rebalance their strategies.

As of 2019, it looked like interest rates would continue to rise. But early on the Federal Reserve halted its tightening campaign, and by summer had reversed course and began loosening rates again. The Fed has cut the target federal funds rate twice in 2019, and at least one more cut seems likely.

With that in mind, there’s a fair amount of uncertainty about how much rates will drop. For savers looking to maximize their returns, it’s time to adopt a strategy that not only considers the possibility of a long period of falling rates, but also the possibility that the interest rate environment could return to change in 2020.

The following steps should help savers maximize the return on your savings in a falling rate environment, with minimal downside if rates surprise us again.

Open an online savings account

No matter what direction rates take now, some of your savings should be in a savings account. It’s a safe place to keep the money you’ve saved for emergency expenses and short-term goals.

If you want an account that earns as much interest as possible, an online savings account is your best bet. The average rate on online savings accounts has a history of beating the average at brick-and-mortar banks, usually by a significant margin. This spread has been wider when rates were rising, but it has also remained fairly wide when rates have fallen or bottomed out, as was the case when the fed funds rate stalled near zero after the Great Recession. During those years, the average online savings account rate was nearly four times what brick-and-mortar banks offered.

When rates drop, look for online savings accounts that have a track record of offering competitive rates. It’s common for banks to be aggressive with fees when they launch new online savings accounts, but as their account offerings mature, they tend to become much less competitive.

Choose online savings accounts that make it easy to move your money around. That way, if your account rate drops more than other banks, you can quickly and easily move your money to higher-rate accounts at other banks.

Choose a savings account that doesn’t have a minimum balance requirement, so you can move your money around without worrying about low balance fees.

Finally, the bank you choose should offer options that allow you to quickly transfer money to other banks. Make sure transfers go through within one to two business days and be aware of small transfer limits.

Open a CD without penalty

Savings accounts can be disappointing when rates drop. This is especially the case for online banks that tend to respond quickly to changes in the federal funds rate. As the Fed cuts rates, online savings account fees will generally follow. A certificate of deposit, or CD, has an advantage over a savings account when rates fall because once a CD is opened, the rate is locked in until it matures.

The downside to a standard CD is that if you access the money before maturity, you’ll have to pay an early withdrawal penalty. No-penalty CD eliminates this drawback. You have free access to your money in a CD with no penalty before maturity. The only exception is the first six days after opening the CD. Regulations limit access to any CD during this time.

No-penalty CDs aren’t a common product, but some online banks and credit unions have started offering them in the past year. It’s best to have a penalty-free CD and an online savings account at the same bank. In this case, you can easily open penalty-free CDs with money from your savings account.

Whenever you need the money, close the CD without penalties and move the funds back into the savings account. Look for penalty-free CDs with the longest term to benefit from rate locking.

Open a standard CD with a light early withdrawal penalty

The downside to no-penalty CDs is that the fees are often not much higher than the fees on online savings accounts. Standard CDs typically offer higher rates than savings accounts and no-penalty CDs. Also, standard CDs have longer terms, which can be useful during long periods of falling rates. Choosing a standard CD for a portion of your savings can be a useful strategy when rates drop.

The problem with standard CDs is that if you need to access your money before the CD matures, it can be expensive. The early withdrawal penalty may cost you some or all of the interest earned.

If the interest rate environment changes and rates start to rise again, you may want to move the money from the CD to a higher rate account. This is the advantage of choosing CDs with light early withdrawal penalties. This minimizes the cost of moving your money around.

For CDs with terms longer than two years, look for early withdrawal penalties that don’t exceed six months of interest.

Open an additional CD

With a standard certificate of deposit, the only time you can deposit funds is when you open the account. After the initial funding, no further additions can be made until the CD matures. An additional CD allows the holder to make additional deposits during the term of the CD.

This type of CD can be useful when rates are falling. Like standard certificates of deposit, a bonus CD’s interest rate is locked in until maturity.

Here’s your game plan: Open an additional CD with the minimum initial deposit. If rates continue to drop, put any additional funds that are available into the bonus CD. As interest rates go down, the return you’ll get on the bonus CD will be higher than the rates offered on the new CDs.

If rates start to rise again, don’t make additional deposits into the bonus CD. This small minimum initial deposit limits the downside of having your funds locked up in a long term CD when rates rise.

Bonus CDs are even less common than no-penalty CDs, but some online banks and credit unions offer some. Look for additional CDs with long maturities. A long term makes the add-on feature very beneficial when there is an extended period of low rates.

Be sure to look for additional CDs with minimal deposit restrictions. Depending on the account, there may be restrictions on the number and size of additional deposits. Both can reduce the usefulness of an extra CD.

The best strategies for savers

As we have learned, the future path of interest rates is highly unpredictable. Rates may be falling now and look likely to continue falling in the near term. But no one knows how long this downward trend will last.

The best strategies for today’s savers are those that maximize returns if rates should continue to fall, but allow for easy changes with minimal costs if rates take another dramatic turn.

Ken Tumin is the founding editor of The Bank Deals Blog a DepositAccounts.comwhere he covers banking operations and deposit investment strategies since 2005.

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