With the Federal Reserve expected to cut interest rates for the first time in over four years, the interest on high-yield savings accounts is likely to follow. Many of you might be wondering what to do, but don't panic—there are three options I'll cover in this video for managing your high-yield savings when the Fed cuts rates.
Let’s dive into how to manage your high-yield savings account when interest rates drop.
When the Federal Reserve cuts its federal funds rate, banks typically follow by lowering the rates they charge on loans and the interest they pay on deposits like high-yield savings accounts. This is great for borrowers, such as those looking for mortgages, but not so favorable for people with high-yield savings accounts, who have benefited from high interest rates in recent years.
Still, this could be a good time to reassess what to do with the money in your high-yield savings account. The best option will depend on your unique goals and situation.
The first option is simple—do nothing.
The main purpose of a high-yield savings account is liquidity, or easy access to your money, which is crucial for things like:
While a drop in interest rates reduces the "free lunch" you’ve been enjoying, the account’s primary function hasn’t changed. The interest rate is just the cherry on top.
A common rule of thumb is to keep 3 to 6 months' worth of living expenses in a high-yield savings account. However, I often recommend:
So, even if rates go down, keeping this money liquid for short-term goals remains the top priority.
If you’re not satisfied with the lower rates, consider shopping around for higher yields:
These alternatives often allow you to lock in rates for a set period, which can be beneficial if you have specific future expenses. For example, if you plan to buy a house in two years, locking in a higher rate with a 2-year CD might make sense.
However, keep in mind that CDs and Treasuries require your money to be invested for a certain period, which makes them better suited for planned, future expenses rather than emergency funds.
If you’ve reassessed your emergency fund and short-term savings, another option is to invest the excess in riskier assets like the stock market.
For example, if you have extra cash in your high-yield savings account because you were enjoying guaranteed 5% returns, now might be a good time to shift that money into the market for longer-term goals.
Historically, the stock market has provided much higher inflation-adjusted returns than cash. Since 1926, U.S. large-cap stocks have returned an average of 7.19% annually after adjusting for inflation, while high-yield savings accounts and money market accounts have only returned 0.31% on average.
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Of course, the stock market comes with short-term volatility, which is the price you pay for higher long-term returns. If you're committed to a long-term strategy, investing excess cash can significantly grow your wealth over time.
Here are some investment options for your excess cash:
Hopefully, these three options give you something to think about as the Federal Reserve prepares to cut interest rates. Whether you choose to do nothing, shop around for better rates, or invest excess cash, the key is making a decision based on your financial goals and time horizon.
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