Why Are Interest Rates So Low Right Now? (and Where Should You Put Your Money?)
Published on - August 24th, 2010 (Modified on - September 7th, 2011) (by J.D. Roth) I’ve been plowing through my e-mail lately in my never-ending quest to reach inbox zero. As a result, I’ve been answering tons of reader questions. And when I can’t answer them (or when I think a colleague can do a better job), I try to refer the question to somebody else.
Over the weekend, for example, LP wrote:
I’m a college student and have started saving up and setting aside money, and I feel that the time has come to consider a high-yield savings account, a certificate of deposit, or something similar. It would appear to me that in the time that’s passed since you wrote articles on these types of things (and also helpfully comparing some, thank you), the interest rates have dropped from 4-5% on average to 1-2% on average. Why is that? Is it the economy? Should I sign up for interest rates this low, or should I wait and hope that they increase?
Though I understand the basic reasons that interest rates are so low, I decided it made more sense to ask my colleague Richard Barrington from Money Rates to chime in with an authoritative answer. All of the info in the next section is directly from Barrington.
Why interest rates are so low right now
LP has hit the nail on the head: The economy is the reason interest rates are so low right now.
When the economy is weak, people and businesses are less inclined to borrow money. Like anything else, the cost of loans is affected by supply and demand, and low demand for loans means that the cost of loans — the interest rates — has come down.
Adding to this, the Federal Reserve has moved to lower interest rates. These actions range from lending money to banks at extremely low rates to buying bonds on the open market, which drives market interest rates lower. By lowering interest rates, the Fed hopes to stimulate the economy.
Their reasoning is that if loans are cheaper, more people and businesses will borrow, spending will rebound, and the economy will be on its way again. This hasn’t worked particularly well, however, because many people are already swamped with debt, and banks have been reluctant to lend money because they got burned in the housing crisis.
So, where does this leave us? According to the FDIC, savings account rates now average 0.19%, money market rates average 0.27%, and 1-year CD rates average 0.68%. However, you can do somewhat better than these rates if you shop around. For example, the best money market rates are up around 1.50%.
One silver lining is that while interest rates are low, inflation has also been quite low; in fact, some economists are talking about deflation rather than inflation in the months ahead. Still, no matter how you slice it, today’s interest rates are unusually low. Any decisions you make about those rates should be considered in the context of the fact that these rates are very much out of the ordinary.
Also, your level of optimism about the economy should be a factor. A more robust recovery would increase demand for loans, and would also eliminate the need for the Fed to keep pushing rates lower. In other words, a stronger economic recovery would most likely push interest rates higher.
What should you do with your money?
Thanks to Barrington for taking the time to answer LP’s main question. As for LP’s secondary question — “Should I sign up for interest rates this low, or should I wait and hope that they increase?” — the answer is: It depends.
My philosophy is that your decision about where to put your money should be less about the potential returns than about your eventual use for the cash. In general, stocks will earn more than bonds, which will earn more than CDs, which will earn more than savings accounts. Not co-incidentally, the higher the potential return, the more risk or drawbacks an investment option has.
All of this is to say: If LP needs his money next year, he probably shouldn’t invest it in the stock market. Yes, the long-term average return on stocks is about 10%. But “long-term” is measured in decades. And average is not normal. Those stocks might go up 30% in the next year, or they might drop 50%. If LP needs the money, he should put it somewhere safe, which probably means a CD or a savings account.
No, a CD or a savings account won’t give LP the 4% or 5% returns of years gone by. But as Barrington notes in his summary above, those interest rates should be back once the economy improves. The most important thing to understand, though, is that when you’re saving for the short-term, high interest is a bonus. What you really want is for your money to stay safe.
What about you? With interest rates so low, where are you putting your cash? Have the low rates prompted you to move your money to the stock market? Have you opted to make major purchases? Or do the interest rates influence your decision at all?
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i have two cds.$6655 an $5075 in my local bank for my e.fund along with $1000 i keep in my c.account,also $10857 in ing.making only 40 cts a day.jus started my 401k 20% of my check about $200 a week,$1860 so far,pick up every lose penny i see on the ground,bring my own coffie cup in stores for refill price,saving money in fun for me now like a hobby.this is what i have in just over a years tm.thx.get rich slowly.
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My stuff is in a savings account (1.1%) and a high-yield checking account (3.45%).
I’d recommend not let low interest rates stop you from saving. LP will still have the opportunity to grow their money (if slowly) with even the most basic of savings accounts.
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If you have credit card debt then you can easily earn 12 to 18 percent on your money by paying off your credit card loan.
With 5 year bank CDs you have to pay taxes which diminishes your return.
If you have a mortgage then you can earn a guaranteed return rate of 5 percent on your money by paying off the money you borrowed from the bank to buy your house.
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I have the maximum amount in my rewards checking (they pay the highest rate up to a certain amount) and some in a savings account at the credit union. A 12-month and a 2 year CD at Ally Bank, a bunch of $ in Capital One online savings, some in Capital One MM, three Smarty Pig accounts, $250 in Lending Club because I just started doing that, and I want to see what happens, and some $ in a short-term bond fund. I contribute automatically to both Capital One accounts, the Smarty Pig accounts and the bond fund plus the credit union savings account each month. I also pay extra on the mortgage each month, but have been thinking about putting an additional $5-10K toward it each year at the end of the year so I can get it paid off ASAP.
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I’ve got my $$$ in a few places. My emergency fund resides in an ING Direct savings account. I also keep several hundred dollars physically on hand (never know what might happen). I run a rather aggressive portfolio at Betterment.com (ETFs, so subject to full principle loss), and run a more conservative setup in my Vanguard 401(k). Now, if only I had more $$$ to contribute to each! I’m working on paying down debts right now, though.
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There are a few low risk options. I’d either save cash at 2.15% at Smart Pig or open a rewards checking account with a credit union that would make 3-4% as long as you direct deposit and debit 10-12 items a month. First Community is the closest credit union to me to have those rates. I’d shy away from 5 year CD’s since Smarty Pig is about the same and you can access your cash in about 3 business days. Good luck!
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Emergency, vacation and miscellaneous savings accounts with Smarty Pig for easy access and user-friendly conditions.
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For readers of a finance blog, I am staggered that out of 57 comments only one or two readers invest in the stock market or in bonds. Savings accounts? Checking accounts earning 1% or so? I am so surprised.
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A really low risk option is to put your money in extra food, household supplies & everyday items, then when times get even worse you have some extra for yourself & to share with others.
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I agree with #58 there are some excellent dividend plays right now with a decent safety margin in the market. Right off the bat I would suggest ‘T’ and ‘LINE’ although I preferred ‘T’ a month ago as it’s price has risen I suspect as more investors seek the safety of it’s dividend. Still yielding over 6% with about as safe a dividend as is possible. Likewise CL, LLY, KO are all good safe plays as well.
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I would put extra money in your home. Even if your mortgage rates are under 5%, are any of your investments earning that? Probably not…
The stock market is a black hole, it has not really returned anything in 10 years. I would like to see where the writer came up with 10% over time – I do not believe that. Look at the last 20 years, not the last 100.
Think outside the box such as rental property. It can be a headache but it can also provide you some recurring revenue later in life.
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It seems most comments above sited the following three options as best for now:
1. local bank or credit union savings account or CD
2. online web 2.0 savings account such as Smarty Pig, Ally or eVantage
3. cash back or rewards checking account
I would have to agree on seeking out local bank or credit union bank promotions right now for short term investing and or emergency fund placement, and seeing what they have on offer.
You might get lucky and score a rate above 3%. Try it.
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The best line in this post is “My philosophy is that your decision about where to put your money should be less about the potential returns than about your eventual use for the cash.”
If you will be using the money in the next few years, the impact of lower interest rates is negligible. If you are saving money to buy something two years from now (a house or a car, for example), a 4% interest rate instead of a 1% interest rate will only allow you to make your purchase a month or so sooner!
Furthermore, when you consider real (inflation adjusted) interest rates, there is very little difference between today’s rates and historically normal rates.
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Back when interest rates were higher (circa 2006 I think?) I would always try to find the best rate. First it was Emigrant Direct then it was ING (their high interest checking especially appealed to me).
But now that rates are low I could care less. I would rather just have simplicity. So all of my cash is with ING. I do have $2,000 in an ING CD that will mature in December. We’ll need the cash eventually so the only money that goes into the stock market is for retirement – through our 401(k)s or Roth.
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Foreign bank accounts if you are able to. Most developing countries have global banks such as Citi and HSBC that pay 4-7% interest on cd deposits… When times are better interest in those accounts were at 12%
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ING Direct and dividend paying stocks
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High interest checking is the way to go. I am getting 4% on a checking account maxed out to $25k. I did a blog posting about it, the bank is called Bank of the Sierra. The rules for the account are quite easy for me also.
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I’m retired and receiving a good pension. I’m also getting Social Security. My wife has a great retirement plan and she’s been completely maxed out on all optional portions of the plan since she started working for her organization 20 years ago. We have after-tax investments, all in stocks or mutual funds, and the rest of our money is spread over four relatively high yield internet banks – ING, HSBC, Ally, and our local credit union. All of the savings is immediately liquid and can be pulled back to our local credit union with nothing more than a simple request. Right now, our savings are getting about 1.35%. It isn’t much, but it is better than we can get locally. Because of the FDIC insurance limits, we have had to be quite careful to insure that none of the accounts ever exceeds the “OLD” level ($200,000 for joint accounts); I would love to consolidate down to only two sources – credit union and one Internet bank, but the FDIC limit prevents us from doing so. We could ladder CDs but the interest rates aren’t significantly higher for the loss in liquidity. It isn’t that we expect to need the money for an emergency, but it is there for one, and we expect to draw down money upon which we’ve already paid taxes before we start on tax-deferred accounts.
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Being 25 and having just finished paying off my debt, I have my 6 month emergency fund and a fund to pay my taxes in a savings account earning so little I cant even quote it. I have my 401k with a few types of mutual funds; a Roth with 4 Diff funds; and I have some non retirement investments in Mutual funds and single selected stocks. The money I know I will need short term is easily accessible and can be in my checking account in seconds. It isn’t there to make me money. Everything is in the stock market in one way or another. Eventually I will add a few gold coins to my portfolio.
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I’ve gone to stocks, with pretty good luck. I’ll have to keep my fingers crossed though. I’ve been surprised at how well some of the small and mid-cap guys are doing right now. It seemed a bit strange. Maybe people are intentionally looking around for the smaller guys out of spite for the mega-cap guys. Who knows anymore.
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Get an education, pay off debt. Get a room mate to cut expenses in half. Save up $1,000 per month. When gold is cheap and stocks are expensive buy gold. When stocks yield 6% on the Dow or S&P, buy stocks. Another angle is buy real estate. This takes leverage and a job. Build your estate. Save up 6 months spending, then save up 25% each in cash, stock index fund, 30 year bonds, and gold bullion stored at home. Rebalance when one is above 35% or below 15%. Invest by per cent not dollars. Beware of bank debt notes as money. Bank debt notes have lost 90% of their buying power since 1971. US silver coins have retained their buying power since 1963 with no loss of buying power. Think about that.
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If I can only afford a minimum balance for a cd which is about average $1000, as I’ve seen around, and even at a more than best case scenario of an APY of let’s say hypothetically 5.0%; the actual interest amount gained is $50 at a years maturity,which is less than 50% of most average cell.phone bills in a month. This doesn’t sound like much of a.savings prospect for most.people. It seems looked CDs only really pay if one has thousands off the batt to invest. It seems like only millionaires have any real benefit to this say $1000000 at 5% APY. Let’s face it, how many average people have $1000000. To me it doesn’t seem like CDs are for an average Jo. Typing up a $1000 for a year for only $50 extra just doesn’t look practical or worth it; and that’s even at a more than best case scenario APY. Am I right or am I just being greedy, please let me know your thoughts.
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