When you think about money, it comes down to how you earn it, how you spend it, and the various demands for your dollars. With high demand on goods, shortages of supplies, and changes in the labor force, inflation became the main threat to our economy in 2022.
There is an equilibrium between inflation and interest rates and the impact on the economy. Increasing the money supply makes each individual dollar worth less. This can stimulate the economy but at the cost of higher inflation. The Federal Reserve System handles the monetary policy that influences how money functions in the financial system and controls the target borrowing rate, “Fed rate,” which dictates interest rates in the economy. In 2020-2021, the Fed increased the money supply and lowered rates attempting to prevent a pandemic-driven recession.
In 2022, however, the situation changed. The economy rebounded and then some. Goods and services were in short supply and prices were rising. As a result, the Fed implemented a contractionary monetary policy, increasing the Fed rate 7 times last year to a target range of 4.25- 4.5 percent. The Federal Reserve indicated that the fed rate will continue to rise in 2023.
Although borrowing costs are up, it that also means that rates for savers finally began to rise, though there is dramatic variation between the rates being offered on deposit accounts. Bond rates, including Treasuries (bills, notes, and bonds), municipal bonds, and corporate debt are being issued at higher rates. However, many of the largest banks continue to pay very low interest rates so the higher rates are benefitting some savers more than others.
What are online banks all about?
Online banks generally offer account holders higher interest rates because they do not have the overhead that many brick-and-mortar banks have. Some banks have only savings accounts and no ATM access so you will need to do your research and look at the pros and cons for each bank you are considering. Below are some of the larger online banks to consider:
Please note that these are not recommendations but are merely examples of what is available. Before opening an account, remember to compare your options to find the best fit for your financial needs.
Online banks are competing for your cash with interest rates ranging between 3% to over 4% with the average rate at 3.3% APY* (Jan, 2023). Some great resources to evaluate online banks are at DepositAccounts and Bankrate.
Certificates of Deposit (CDs) are where you lock in your cash for a certain amount of time. Online banks offered an average yield of 4.15%** on a 12-month CD (Dec, 2022). The risk is interest rates going up while you are locked into a current rate – or investing money you need before the time is up. The rate of a CD needs to be high enough to justify locking up your money for the intended term.
Other options to consider are:
Let’s first start with what a bond is. A bond is a type of loan issued by corporations, governments, and other entities and sold to investors. In return, the investor will earn interest for a fixed period of time and, when the time is up, the issuer repays the bond in full. The coupon rate is the nominal yield on the face value of the bond. Typically, bonds pay interest twice a year based on the coupon rate on the bond value at purchase.
Bond investors face risks such as interest rate risk, reinvestment risk, inflation risk, liquidity risk, default risk, etc. There is an inverse relationship between interest rates and bond values. As interest rates rise, bond values decrease and vice versa. What we have seen in the bond market is prices for existing bonds dropping rapidly as the interest rate rises. This is because rising rates mean investors can buy brand new bonds paying a higher rate.
As prices decline, the interest rate as a percentage of the cost of the bond rises. For example, a bond paying $3/year may feel stingy at $100. But if the price drops to $80, you’re getting a higher portion of your investment returned in interest each year.
This is for investors who are seeking a steady of income with a goal of increasing their return in a rising interest rate environment. With interest rates increasing, a conservative approach is to spread out the maturity dates of multiple bonds. By purchasing bonds with different maturity dates, when a bond matures the funds can be reinvested in a newly issued bond at the higher rates. A bond ladder is designed based on the average period of time that a bond is to be held until maturity. By having a set of bonds mature (and getting the original par value back) and reinvesting in new bonds or utilizing that cash over a period of time, risks such as market risk and reinvestment risk are somewhat mitigated.
A short-duration bond strategy may be where an investor holds bonds with maturities at 3 months from one another. For example, an investor holds 5 separate treasury notes maturing on 3/31/2023, 6/30/2023, 9/30/2023, 12/31/2023, and 3/31/2024. The first note matures on 3/31/2023, is redeemed at par value with the coupon’s interest for that maturity date. The investor buys a new note set to mature 15 months out for a maturity of 6/30/2024. With interest rates rising, this allows the investor’s effective interest rate to increase over time with 3-month reinvestment intervals. This two-year U.S Treasury note issued on 1/3/2023, has a coupon rate of 4.25% with the price per $100 purchased at a slight discount allowing the yield-to-maturity being higher than the coupon rate. Since treasury notes are in circulation, the investor has the ability to purchase notes maturing much sooner than the 2-year maturity.
While there are many options to help increase the return on your cash, not all of them are fully liquid or risk-free. It’s important to look not just at the interest rate being advertised but the type of instrument. FDIC savings and money market accounts can be appropriate for an emergency fund, even if they’re held away from your regular bank or credit union, but other options either add risk or limit liquidity. These may be more appropriate for extra cash beyond a 3 to 6-month cushion or money that might be needed within 3-5 years or more. If you’re looking at your bank account statement and still receiving an interest rate well under 1%, it may be time to shop around, revisit your financial plan, and figure out how to make your money work more for you.
Please note: This is a hypothetical example for illustrative purposes. The performance is not indicative of the performance of any particular investment or strategy. Bonds have fixed principal value and yield if held to maturity. Prices of fixed-income securities may fluctuate due to inflation, credit and interest rate changes. Investors may lose money if bonds are sold before maturity.
Maritza Rogers (CA Insurance License #0E50369) of Athena Wealth Strategies is a registered representative of Lincoln Financial Advisors Corp. Securities and advisory services offered through Lincoln Financial Advisors, a broker-dealer (member SIPC) and registered investment advisor. Insurance offered through Lincoln Marketing and Insurance Agency, LLC and Lincoln Associates Insurance Agency, Inc. and other fine companies. Branch Address: 1510 Fashion Island Blvd, Suite 210, San Mateo, CA 94404. Branch Phone Number: 650-377-4108. Athena Wealth Strategies is a marketing name for registered representatives and investment advisor representatives of Lincoln Financial Advisors.
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Julie VanTilburg, CA Insurance License #0C21028; Maritza Rogers, CA Insurance License #0E50369; Robin Starr, CA Insurance License #0G64012; Jeffrey Better, CA Insurance License #0182274; Kaitlyn Zawada, CA Insurance License #4084200
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