Economic and social impacts of the coronavirus are still unfolding and the federal interest rate has moved to near zero. From stressing our healthcare system to millions of layoffs to business closures to mandated social distancing, we haven’t been faced with an economic crisis of this scale since the Great Depression.
In response, the Federal government is doing what it can to keep the economy afloat. On March 15, 2020, the Federal Reserve cut interest rates to near zero in an effort to balance the economy.
So what are federal interest rates? How do they work? In what ways will this “near-zero” rate impact you? Let’s find out.
Breaking Down the Federal Interest Rate
When people refer to interest rates they are often talking about the target federal funds rate or short term interest rates. But what does that really mean?
The federal funds rate refers to the rate that banks charge other banks for lending them money to meet their bottom line.
By law, a bank must have a cash reserve that equals a certain percentage of their deposits. This law is in place to make sure banks have enough money to handle the ebbs and flows of customers’ deposits and withdrawals.
If a bank is concerned about falling short on their reserve requirements, they can get a loan from another bank who anticipates a surplus of cash during that period. The interest rate that the banks charge each other is the federal funds rate, or the fed funds rate.
Who Sets the Fed Funds Rate?
A monetary policy-making body from the Federal Reserve called the Federal Open Market Committee (FOMC) gets together to set the federal funds rate. This group meets eight times each year, and sets the rate based on the economic climate. In extenuating circumstances, the FOMC can meet outside this schedule, which is what they did in March.
But this committee doesn’t have as much power as you think.
The FOMC can’t exactly force banks to charge a certain rate, so they set a target federal funds rate which is a range that they encourage. In March, the target federal funds rate was set from 0%-0.25% which is where the phrase “near-zero” originates.
The actual interest rate that a bank charges is determined through negotiations between the two banks and the weighted average among all transactions of that nature is referred to as the effective federal funds rate.
So how can the FOMC get that into their target range? They may not be able to mandate an exact fed funds rate, but they can have the Federal Reserve system adjust the money supply to sway interest rates in a certain direction by adding or removing money from the financial system. By adding money, they increase supply and drop the effective rate. The opposite is true for taking money out. By doing this, supply decreases which makes the effective fed fund rate rise.
How the Economy is Impacted
The federal funds rate is one of the most important interest rates in our economy because it impacts our financial condition as a country, which causes a ripple effect on other aspects of our economy like employment and inflation.
The Federal Reserve’s ability to add or detract money from the financial system can have a secondary effect on interest rates that we encounter in daily life like auto loans, home mortgages, credit cards, and savings accounts.
Many lenders set their rates based on the prime lending rate, or the rate of interest the bank charges their A+ clients (top credit) which is also impacted by the federal funds rate.
Investors also keep an eye on the fed funds rate as its activity tends to correlate with market trends. The market often reacts strongly to this rate which makes it an area of interest for many investors, brokers, and analysts.
Let’s look a little more at how the addition and subtraction of funds work for the economy at large.
Why Lower Interest Rates?
When the federal funds rate decreases, interest rates tend to fall along with it. This can be a really good thing, especially in terms of debt like auto loans, home mortgages, and credit cards. But this also decreases the amount of interest you can expect to get from your savings account or certificates of deposit (CDs).
For you, this means that when the federal funds rate drops, the government is encouraging spending over saving. By promoting borrowing money with better interest rates, the economy can be filled with some much-needed cash. When the economy needs some help, which it does now, lower interest rates will promote greater economic activity.
Why Raise Interest Rates?
Just like the Fed can decrease rates to bolster the economy, they can also raise rates to help ward off inflation. When the fed funds rate increases, interest rates tend to climb which is good news for your savings accounts and CDs as they will often see a greater return. But it isn’t so wonderful for other loans like credit cards or home mortgages.
When interest rates go up, it benefits people more to save money as opposed to spending it. Why would the government want to slow down spending money? The main reason is to keep inflation at bay and discourage a level of economic growth we couldn’t keep up with.
Practical Ways 0% Interest Impacts You Today
So now that you have an understanding of how the federal interest rate system works, you probably want to know how this “near-zero” situation affects your day to day life. COVID-19 has changed the way our economy has functioned and not for the better.
To incentivize greater economic activity, the government wanted to slash interest rates as close to 0% as possible. This will (hopefully) help promote regular economic activity so businesses can run, pay employees, and give people money to put back into the financial system. Let’s take a look at a few ways these low-interest rates could impact you.
Look Into Refinancing
Since lower interest rates can have a significant impact on your debt, now is a good time to reevaluate the debt you have to see if you can refinance or consolidate any of it for a more lucrative rate.
First, take a look at the type of debt you have, and what interest rate is associated with each. Some interest rates are fixed whereas others are variable. Many variable interest rates on credit cards, for example, might be lower during this time which can help you pay that debt off quicker. For credit card debt, you can also look for 0% balance transfers but be sure to read the fine print as that rate may only be in effect for a short period of time.
If you have multiple private student loans, consider refinancing those to a lower interest rate. In most instances, refinancing federal student loans isn’t as beneficial as they have more flexible repayment options and low-interest rates to begin with.
For those of you with a home mortgage, now is a great time to shop around for other lending options. Even if you closed recently, refinancing to a lower interest rate will impact the amount you pay over the lifetime of your loan.
Most people recommend refinancing if the interest rate is at least a full percentage point lower than your current one, but each person’s needs will be different. Keep in mind that in the refinancing process, you will need to have extra cash on hand for closing costs which can be significant depending on if you need to purchase points to lower the rate, the total amount you have left on the loan (private mortgage insurance) and the lender fees.
The pandemic has caused a lot of turmoil for people’s personal financial health, impeding some from being able to pay their bills and make ends meet. Should you be under tough economic distress, take some time to look at the options available to you.
The first thing will be to take advantage of the CARES Act stimulus check, which is $1,200 for those who filed taxes single and $2,400 for those who filed jointly. As a business owner, be sure to look into other CARES Act relief funds like the payroll protection plan and other provisions designed to help keep your doors open.
If you need to borrow money, now could be the time to do it. Start by looking at all of the options you have available to you: personal loan, credit card, business loan, etc. and start with the one that has the lowest interest rate. Also, look for a fixed interest rate so as not to incur a massive surprise when the fed funds rate increases again. It is always important to borrow money with caution. Do your research and only borrow what you need to.
Know Your Savings Accounts Won’t Grow As Much
Seeing the numbers on your savings account grow from interest payments is a great feeling, but with the fed funds rate so low, don’t anticipate as large of an interest payment as usual.
Many savings accounts’ interest rates have a close relationship with the target federal funds rate. With the current range from 0-.25%, most banks aren’t making any money on the bank to bank loans which doesn’t give them a lot of wiggle room when it comes to interest rates they pay on savings accounts.
The world of federal interest rates can be a bit overwhelming, but know that you don’t have to tackle it all on your own. Our team is here to help you make smart money choices that give you the power to live life on your own terms. Even in these uncertain times, we are here to help you. Get in touch with us today.
Episode 01: Welcome to the Work Your Wealth Podcast
Welcome to the first episode of the Work Your Wealth Podcast, a weekly podcast for those wanting to make smarter choices with their money.
Featuring expert interviews with leading authors, business owners and professionals, the Work Your Wealth Podcast will give you the education, confidence and clarity around your finances that you deserve. If you’re ready to use your money to live a life you love, this show is for you.
I’m your host, Mary Beth Storjohann. I’m a CERTIFIED FINANCIAL PLANNER™, the Founder of Workable Wealth, where I serve as a financial planner and accountability partner in working to help clients in their 20s-40s across the country make smart, educated choices with their money.
I’ve been named as a “Top 40 Under 40” financial planner by Investment News, one of “10 young Advisors to Watch” by Financial Advisor Magazine, and one of “10 of the Best Personal Finance Experts on Twitter.” I frequently appear on NBC as a financial expert and my expertise has been featured in Glamour, Women’s Health, Brides, The Wall Street Journal, CNBC, Forbes, and more. You can connect with me via Instagram, on Facebook, or via Twitter.
In this inaugural episode of the Work Your Wealth Podcast, I talk about why I created this show, share a bit about my background, and explain who this podcast is for and what you can expect each time you join me here.
WHAT YOU’LL LEARN FROM THIS EPISODE:
Introduction to me, Mary Beth Storjohann and the Work Your Wealth Podcast.
How I ended up in a career as a Financial Planner and started Workable Wealth.
When you’ve built up a surplus of cash, it’s hard to feel like you’re doing anything wrong. After all, a surplus is indicative of a frugal lifestyle built on a foundation of spending less than you earn. Who could criticize that?
But money is more than just a resource you need to stock up – it’s a tool that can create even greater wealth if used correctly. In other words, money that’s just sitting around is a wasted opportunity.
There are plenty of things you could be doing with that extra cash that are low-effort and low-risk. If you’re ready to get your money working for you, consider these options.
How Much to Keep on Hand
You’re going to hear varying numbers here, but you should aim to keep six month’s worth of your must have expenses as an emergency fund (think rent, mortgage, utilities, groceries, insurance, and essential items you’ll definitely need to pay for no matter what). That amount will cover you in case you lose your job, face a prolonged illness or have to take time off work to care for an ailing relative. If you work for yourself or have children, you might consider saving a year’s worth of expenses just in case.
Any cash you’ve tucked away for an emergency account should be kept in a high-interest savings account. A savings account is the perfect tool for this because it’s liquid enough that you can access it within a couple days, but not located in the same checking account you use for daily purchases. You can use the same bank you use for your checking account or another if it offers a better rate.
A high-yield savings account will usually earn you around 1% interest a year if you’re lucky. That amount won’t match inflation, but it’s better than a checking account paying nothing.
Why Keep It Elsewhere
You risk losing money when you store excess cash in a checking account or under your mattress. Money’s like a plant – it can only grow if it’s kept in the right environment.
The longer you keep cash somewhere it’s not growing, the more you lose due to inflation. That means if you keep $1,000 in a checking account that’s not earning interest, it’s worth less every year.
Think of your money as an opportunity. The choice of whether to waste or seize that opportunity is entirely up to you.
It’s important to note though, that while you want to maximize the amount of interest you earn on your emergency fund, this is one chunk of money that for your financial planning purposes, isn’t meant to be invested or utilized in any way that could lose your principal balance. This emergency fund is meant to be available in case of emergencies, and last I checked, we don’t know when those will happen. There is an opportunity to earn more growth and income when deploying additional funds into savings accounts for retirement.
Other Savings Goals
Cash you’re saving for things you’ll need in the next three to five years doesn’t need to be kept in a savings account.
One popular option for short-term savings goals is a CD that will mature in a few years. A CD is insured by the bank and has a specific time in which you hold it. Rates will vary based on the bank you choose, how much you can deposit and where you live. You can compare rates online at Bankrate or NerdWallet.
Money market accounts are another option if you won’t need the money for a couple years or more. Some have higher rates than savings accounts and are also backed by the FDIC. Bonds are another option, but rates vary depending on when they mature and how the economy is doing. Your best bet is a CD or money market for short-term goals.
Invest the Rest
Once you’ve allocated money for your emergency fund and short-term savings goals, it’s time to invest any remaining funds for retirement. This money should be deposited in an IRA, 401k or other long-term savings vehicle. These accounts can provide a much greater return because you won’t have to access them anytime soon.
Popular options for retirement savings include index funds or target-date funds, most of which have low fees and decent returns. A financial advisor or planner can help you pick a fund if you‘re unsure which to go with.
Bottom line, if you’re sitting on more than six months worth of expenses in cash, it’s time to get a plan in place for how to allocate the rest in order to ensure your money is being put to work for you.
When people think of saving money, it’s often translated into feelings of deprivation and if you’re like most people, you probably don’t get excited about depriving yourself. Instead of trying to save money by limiting the things you enjoy in life like dining out or travel, there are ways to save creatively by reducing taxes (meaning more money in your pocket) or limiting lifestyle overhead expenses (such as utilities and living costs).
Here are eight creative ways to save cash (that we practice in our house too):
• If you have $1,000 set aside in an emergency fund, take a few minutes to bump up your deductibles to $1,000 on your auto or home insurance policies to reduce your premiums. Since you have the funds on hand in case of an emergency, you’ll be able to cover the deductible without using your credit card and also save money by reducing your premiums.
• Pay your insurance premiums annually. Whether it’s life, auto or home insurance, you’ll almost always get a cheaper rate when you opt to pay your premiums annually instead of monthly. The way to prepare for this expense is to open a separate savings account and divide the annual payment by 12. Stash away that amount each month for 12 months so that by the time your premium is due, you’ll have the cash on hand to pay in full and will have paid a lesser amount.
• If you’re a homeowner and haven’t already jumped on the refinance bandwagon, it might be time to quickly consider getting on. Rates have been low for months and are set to increase in the months ahead. Depending on what your current mortgage interest rate is, this could save you hundreds if not thousands of dollars each year. Just be sure to consider the fees involved with the refinance and how long you’ll be staying in the home before jumping in.
• Before hitting “buy” for the items in your online shopping cart, do a quick Google search for “name of the store + coupon codes” to see if there’s any coupons or discounts you can benefit from on the purchase. Why pay full price if the option to save 10-20% is sitting just two clicks away? Also, is anyone else in love with Target’s Cartwheel app?!
• Get a better credit card. If you’re someone who uses your credit card for purchases and then (hopefully) pays off the balance in full each month, you want to make sure your rewards program is working for you in terms of cash back, gift cards or travel. If your credit card isn’t providing the best rewards, check out Nerd Wallet’s list of best rewards credit cards to find one that’s a fit for you. Stocking up on rewards points is a great way to then fund travel and vacations or cash them in for holiday and birthday gifts.
• Look at your company benefits. Does your employer offer flexible spending accounts? If you have children and are paying for daycare while your company offers this benefit, you’re able to stash away up to $5,000 into this account pre-tax (which means you’re saving money on income tax) and then use it to pay for childcare. Assuming a 25% tax rate, that’s $1,250 back into your pocket for the year.
• Brush up on your negotiation skills. Looking for a higher salary, better price on your new car or for more work-life balance? Practice your negotiation skills with a friend or partner before heading in for conversations and deal making. Document your points and practice getting push back. Worst case you get a “no”. Best case, you get what you want, which hopefully means more money in your pocket.
• Get a price adjustment. When you buy something and the price drops within a week or two, you can often get a refund for the difference depending on the retailer’s policy. Using an app like Paribus to review your transactions will help you to find money automatically when they track your purchases.
It’s easy to get overwhelmed when planning a big trip. The options can seem endless, especially if you haven’t traveled a lot. That’s why it helps to get clear on what you want to see and do on your trip. Ask yourself some of the following questions:
Are you hoping to have an outdoors adventure full of hiking and other activities?
Do you want to see medieval churches and old castles?
Do you prefer a cosmopolitan city or a quiet village?
Are you comfortable speaking another language or do you want to go somewhere English-speaking
How long will your trip be?
Are you a hotel kind of person or do you prefer tents or cabins in the woods?
Once you’ve narrowed down what you’re looking for, try searching online for places or countries that match that description. Then, you can read online resources about those places and determine if they still sound like somewhere you want to go. This can include information tourism sites, travel forums and more. Don’t be afraid to get off the beaten path. Just because millions of people flock to London and Paris every year doesn’t mean you have to as well. If Budapest is more your thing, then go there. Travel is not something most people can afford to do often, so it’s important to go where you want – not where you think you should go. After you’ve determined your location, you need to find the best time to go. That will depend on when you can take off from work, how much travel costs during a particular season and what season you prefer to travel in. Once you know when you want to go, you can start developing a rough budget. Then you’ll know exactly how much you need to save.
Fund Your Trip
If a trip abroad isn’t within your current budget, it’s time to find ways to make more money. A trip outside the country can cost several thousand dollars depending where you go. So how can you find that kind of money quickly? Try renting out your place on Airbnb. Airbnb is a great way to make money for people comfortable with sharing their space. How much you earn depends on your city, the time of year and what kinds of amenities your home has. If you have an extra room it can be a great way to make between $66 and $111 a night for renting out something you’re not using. Some hosts make enough to pay their rent in full. Plus, you can rent out your room when you leave on vacation (or the whole place if you don’t have any roommates). Being an Airbnb host doesn’t require any special skills beyond being friendly and accommodating to tourists. Some other money-making ideas include freelancing in your chosen industry, participating in clinical trials, tutoring college and high school students, and picking up retail shifts during the busy season.
Make Travel a Priority
Travel is on the wish list of many of my clients. The best thing you can do for yourself is set up separate travel savings account and stash money aside on a monthly or consistent basis to ensure you’re building up a fund to cover the costs of your trip. It’s easy to pull out your credit card to cover expenses, but your trip won’t be nearly as fun as if you head into it debt free and with the money available to cover expenses. No matter how you choose to fund or save for your trip, the key is to make your travel plans as painless and straightforward as possible. Making room for travel isn’t just about paying for the cost – it’s about fitting travel into your lifestyle in a sustainable and enjoyable way.