Why are interest rates so low right now? (and where should you put your money?)

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 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%.

J.D.'s note: Money-market accounts are technically just savings accounts. However, many banks brand their deluxe savings accounts as “money-market accounts” to attract savers with larger balances. These accounts generally offer higher interest rates.

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?

More about...Economics

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J.D. Roth
J.D. Roth
9 years ago

Yes, I know the original version of this article had a terrible, terrible mistake in the middle. (The same clause was repeated at the beginning of a sentence and again at the end.) This was an editing mistake on my part, and an embarrassing one at that! 🙁

Nicole
Nicole
9 years ago

I’m so lazy… so our cash (emergency fund) is just sitting in credit union savings earning next to nothing. If rates were higher we’d do online savings or ladder cds. I would have more of a motive to get into a term share/cd. Extra cash will probably go towards our mortgage. If the economy were more stable it would go toward the stock market or if rates were higher than our mortgage, it would go to cds. The mortgage has the advantage that it is a choice I get to make every month (unlike retirement savings where it’s a hassle… Read more »

Chickybeth
Chickybeth
9 years ago

For less than $50k, the highest rate I’ve seen now is SmartyPig (2.15%). I keep some money there and some at ING (1.1%), even though ING continues to lower rates when the Fed Fund rate has been at zero for some time. Maybe when rates go up, I’ll start laddering CDs.

Emily
Emily
9 years ago

Take your money and put it in a rewards checking account at a credit union. I earn 4-5% APY provided I use my debit card 12 times a month.

Nick
Nick
9 years ago

Our extra cash is being parked in a few Ally bank 5-year CDs. They currently pay 2.8% but (here is the key) there is only a 60-day early withdrawal penalty. So as long as you plan on having your money tied up for about 6 months, I think it’s the best “safe” parking place out there. When the rates rise, you can withdraw the money, pay the small fee, get the better rate and still end up ahead.

Pop
Pop
9 years ago

I totally agree with J.D.’s recommendation that safety should come first when deciding where to put short term savings. Yield-chasing is what doomed all those investors who put money into “MMA-like” funds only to be screwed when those funds lost a lot of money. That said, why not just put it into a genuine MMA? You don’t need to worry about rates going up, because the account will just adjust its interest up monthly. Personally, I have 6 months of savings in a totally safe money market account, and another 6 months in a short term bond fund earning 4%.… Read more »

Jacque
Jacque
9 years ago

I’m still investing my retirement funds into the stock market through my 401(k) and Roth IRA but only because I am in my twenties and have a few decades until retirement. However, I have no confidence in the health of the economy for the next several years so I am directing short term savings (i.e. house down payment fund) to my account at my credit union which is both FDIC insured and is providing a 3% interest rate. It is a little annoying having those funds mixed in with my everyday checking, but well worth the security and return to… Read more »

Veronique H.
Veronique H.
9 years ago

The Wesleyan Investment Foundation has a savings account with an APR of 2.5% to 3.5% depending on how much you have in the account. They use the money to grow their church, giving loans and assistance. Check out the site here: http://www.wifonline.com/

StevieB
StevieB
9 years ago

I spread my money into three local checking accounts which all offer 3%-4% interest rates. Each require a monthly automatic deposit, but I’ve set that up from one bank to another so there is no manual intervention and need for multiple employers. I make sure I use the debit card the prescribed number of times to get the interest rates.

Daniel Pitts
Daniel Pitts
9 years ago

I first want to say, I’ve been reading your blog for a while, and enjoy it. I had a similar conundrum as LP, in that I have a couple of IRA CDs maturing next month. They were 3.45%, but the new amount is 1% or less (depending on the term). My thoughts, which are admittedly somewhat under-researched, are that interest rates are only going to go up from here, so I’m better off keeping that money liquid for a time being, even if I miss out on slightly higher rates. So I’ve instructed my credit union to roll the IRAs… Read more »

Daniel Pitts
Daniel Pitts
9 years ago

@Jaque, 3% interest? Which credit union is that?

Seth @ Boy Meets Food
Seth @ Boy Meets Food
9 years ago

There is always the high yield checking account option…

I have a checking account with evantage.com that earns 4%, and is credited monthly to my statement. All I have to do is get e-statements, and make 10 debit card transactions/month. BUT, those transactions can be anything… pack of gum, $1 redbox rental, soda, etc. My wife and I use redbox quite a bit, so this was money we were already spending.

Brent
Brent
9 years ago

rewards checking, which recently lowered its rate. That has a 20K limit, if I had that much cash the rest would go to smarty pig. But instead I have my retirement accounts on track to max out at the end of the year. 80%+ stocks because I’m 26, that’s long enough for most all upsets.

Jane Sanders
Jane Sanders
9 years ago

I’ve always thought it’s pretty ridiculous how the government punishes savers. That is a major reason why we have so much debt. Having the Fed keeping interest rates super low (even before the economy went bad) and creating incentives to spend (like tax deductible mortgage interest) means people can get more for their money if they use it NOW, so they do. It’s also a tough choice for those who want to save, to either get a super low rate that doesn’t keep up with inflation, or to try chasing higher yields in riskier assets like stocks. For now I… Read more »

Christina Crowe
Christina Crowe
9 years ago

For now, I’m keeping money in my savings account. I’m not too worried about my interest rates at the moment, so my savings account works pretty well.

Hopefully the economy picks itself up again in the near future.

Hunter Johnson
Hunter Johnson
9 years ago

PNC’s Virtual Wallet includes a “Growth” segment that is basically a high-yield savings account. Rate is currently 1.1%, like ING. Benefit to me is that my primary checking account is already with PNC and I like dealing with their brick & mortar locations nearby. I’m basically ignoring the other two facets of the Virtual Wallet, though.

KC
KC
9 years ago

My husband and I are seriously considering refinancing into a 15 yr fixed. At 3.75% I don’t think we’ll ever see anything as low again. But the payments are scary. We’ll be fine, but I always get nervous when monthly cash flow is less. We have an ample emergency fund in a credit union money market getting around 2% – hey, it’s an emergency fund what else you gonna do with it? Most of our investments are in stocks. There are some strong companies paying dividend higher than a bank account. Other than dividend paying stocks we’re in growth companies… Read more »

Jason
Jason
9 years ago

Discover Bank CD, 3.5% for 10yr. Only 9 months simple interest penalty on any principal withdrawn early, interest is always available. For 2-year money, that’s 2.25% even after the penalty. Break-even v. an ING Savings Acct is only about 13 months. The longer you leave it, the closer your after-penalty rate is to 3.5%.

http://moneywatch.bnet.com/investing/blog/irrational-investor/the-best-cd-in-america/1742/

Ely
Ely
9 years ago

I am not concerned about low interest. Anything is better than nothing, and I have enough in savings that my paltry 1.1% adds up to about a free lunch every month. I don’t bother with CDs because I need the money to be more accessible; if I could still get 3-4% it might be worth it but right now it isn’t.

Karl
Karl
9 years ago

Reward checking / High Yield checking seem to be the best option right now as Seth said. They do come with strings attached, but if you can manage to keep up with the requirements, there are rates between 1-4%. (6% is the higest ive seen, but may not be available in all areas)

@seth – If you are interested there is a service that can help you automate those monthly requirements, so that you can be sure you are earning the highest rate possible from your reward checking account. Its called MicroMaximus. (link in name)

Chris
Chris
9 years ago

This is an interesting topic, and I like to see other peoples perspectives. My wife and I are currently putting away money for our almost an emergency fund in the Lending Club account we have. This may seem quite unsafe, but so far in 2 1/2 years we have never had a delinquent note, and we never put more than $25 into a single loan so we spread our risk. Our average earnings there are at 13% currently. We can also get this money out without to much trouble in just a few weeks. So we are really happy with… Read more »

fetu
fetu
9 years ago

CD’s at a Credit Union. However another good thing is Christmas Clubs. The Santa Club at our local Credit Union is giving 4% intrest right now. You can not take money out of it but in Sept/Oct it is automatically moved over to your savings account. If you do not want to use it for Christmas Shopping you can open up another Santa account and move it back in again. Main downfall is that it only allows $2,500 max. However it is great for saving up some money for next years Roth IRA or for a special event like a… Read more »

Tara
Tara
9 years ago

Emergency fund money is in a savings account, retirement portfolio is entirely in stocks. I have another 25 years to work so I’m feeling optimistic.

davidosomething
davidosomething
9 years ago

kasasa is an org that partners with credit unions that allows them to give 3%+ apy on checking accts. google it

frugalscholar
frugalscholar
9 years ago

Please note: money market accts are not savings accts. They are not FDIC insured, for one thing.

chacha1
chacha1
9 years ago

I am putting $120/mo into our HSA, $80/mo into our 401(k), and $2000/mo into debt repayment – which is giving us the highest “return” of all.

Also have 2 mo expenses in a savings account, safely earning practically nothing. I don’t care; it’s not an investment; it’s an emergency fund.

Pop
Pop
9 years ago

@frugalscholar Money market accounts are indeed FDIC-insured. Maybe you’re thinking of money market funds. While money market funds rarely lose value, they don’t carry FDIC insurance. The difference between an MMA and savings account basically has to do with the number of transactions you can make per month on the account. MMAs limit you to three per month or so.

Since money market funds have lower yields than most money market accounts right now anyway, I don’t see why people would invest in them now.

Rachel
Rachel
9 years ago

I’m always suprised how low US interest rates are. In Australia our rates are lowish at the moment and my ING savings account is giving me 4.5% (plus a bonous amount). But the our home loan rates are around about 6-7% right now. Before the crash, I had a term deposit giving me 8% interest, and savings accounts giving me around 6%

Russ
Russ
9 years ago

#5 – Nick
Thanks for the post regarding the Ally 5 Yr CD @ 2.79 APR! I never realised it was only a 60 day penalty. I calculated vs. Ally saving @ 1.29 APR, you’ll make your money back, even after the penalty, in around 110 days (less than 4 months). I doubt I’ll have the CD for 5 years, but I know I can keep it for 4 months!

Tristan
Tristan
9 years ago

Working in Japan at the moment so I’m not able to get the benefits of retirement accounts. I paid off my student loans a few months ago (thank you exchange rates) and so I’ve started to save using Smarty Pig.

The most attractive thing for me, besides the rate, was the lack of conditions and restrictions. I’m talking about minimum balance, deposit, and/or debit card usage that comes with other accounts. They’re either to much for me as a new saver, or too inconvenient while I’m overseas.

Courtney
Courtney
9 years ago

EF is in a 6-month CD ladder earning an average of 1.5% at Ally (was at 2.1% when we started it). General cash is in online savings accounts. House DP savings is in a conservative high-dividend mutual fund (VWINX – 65% bonds, 35% blue chip dividend-paying stocks) with a target purchase date at the end of next year. I’m very bullish on bonds for at least the next 1-2 years. Retirement funds are mostly stock mutual funds.

sam
sam
9 years ago

i’ve always thought that the more self-sufficient and frugal you are, the more apt a person is to do well in an inflationary environment. that said, some evidence points to the decreasing value of the dollar against other benchmark currencies and biflation (that is somethings like commodities go up in price while the value of good and services goes up, or vice versa). i’ve been buying gold, not etf’s, but metals or stock in metals holding companies like CEF. there are a litany of reasons why and a litany of reasons to disagree with me, but that’s what puts the… Read more »

AC
AC
9 years ago

I think an important thing the article is leaving out is that there is no demand for money right now due to an increase supply of it in the system brought on by large amounts of bonds bought by China/Japan. The government needs to stop injecting money into the economy, decrease the money supply, so banks and businesses can start borrowing and lending again. There is absolutely no sensitivity to interest rates right now due to oversaturation of money and no real increase in income. Right now is a great time put your money in an ETF or stock or… Read more »

Courtney
Courtney
9 years ago

PS – thanks for approving my comment so quickly, JD. I just got a new computer on Friday and I’ve been sent to moderation on pretty much all the PF blogs. My comments over on The Simple Dollar are still waiting to be ‘moderated’ three days later!

Randy
Randy
9 years ago

I fortunately have a 5 CD (5 years) ladder at my local credit union. They have an unusual setup. Although their penalties are higher than most, I can add to the CD’s at any time. For the next 2 years, the two nearest CD’s are at 5.4%, and a third at 4.5%, so as they have been coming due, I move the money into the next. So, outside of shorter term CD’s at Ally and Discover (3.0% and 3.71%), most of my money is making 5.4% for quite a while. Hopefully, the rates will return higher by the time I… Read more »

Steve Bonds
Steve Bonds
9 years ago

Money I might need in the short term is kept in a couple places: 1) Large bills (cash on hand) This is my flee-the-country or bail-the-wife-out-of-jail money. I doubt I ever need to use it but if I do, it’s gonna need to be readily available. 2) Ally bank This is earning nearly negligible amounts, and is easy (but not TOO easy) to get to. This is only for money which might be needed within a couple of days, and those circumstances are thankfully very rare. 3) Brokerage account Most of my short/medium term savings is in here. (85%+) This… Read more »

Dirk
Dirk
9 years ago

Yeah, the state of savings accounts are a bit sad right now. Like most, my money is wrapped up in ING Direct at 1.1%. At least we don’t have any inflation to knock it up!

Passiivinen Sijoittaja
Passiivinen Sijoittaja
9 years ago

Well, I think it’s important to realize that savings accounts or CD:s will (most of the time) only pay enough to beat the inflation. If inflation runs high, so does the interest rates on CD:s.

Those 4-5% returns that we saw a few years ago don’t seem as good anymore when you factor in inflation, though it ofcourse was better to put your money into CD:s than just keep it in a checking account with zero interest.

The Yakezie
The Yakezie
9 years ago

Seek duration i.e. 5-7 yr CDs at 3.5-4%. That’s the best. You can find them at USAA.

bon
bon
9 years ago

Chris (or JD!) — I would love, love, LOVE to hear more about Lending Club and/or other similar organizations.

Stacking_Cash
Stacking_Cash
9 years ago

I moved my money to an online savings account giving me about 1.4% interest. Pathetic, but it’s the best I could do. As I have said before, I would rather lose money by inflation than lose money in the stock market. Funny, I’m truly getting rich slowly.

Bruce
Bruce
9 years ago

We have some of our cash parked in an Australian bank account where we can get 6%. I expect the AUD/USD exchange rate to fluctuate a bit, but over the long term I expect the difference in the rate of returns to outplay any currency movements.

Sandy L
Sandy L
9 years ago

I’ve been paying down the mortgage instead of saving extra cash. I’ll do that until interest rates go back up on long term cds.

I was able to catch a rate of 4% and lock up some $$ at our local credit union but they only ran the promotion for a very short time. Now I check their promotions monthly to make sure I don’t miss out on the next time they decide to run one.

Wayne Mates
Wayne Mates
9 years ago

Excellent article and great timing. One of the things I have done is to move some money out of low yield savings and bought dividend paying stocks such as utilities. At current prices the dividends provide a yield in the 6-7% range. This is money I do not need now so if the value fluctuates a bit, it is quite alright!

bon
bon
9 years ago

Bruce – are you an Aussie? If not which bank?

Jason Fournier
Jason Fournier
9 years ago

It has been said here a few times, but there are many places offering 3-4.5% (not teaser rates) for rewards checking. Also they reimburse for ATM transactions. I just moved some of my money into one. Unfortunately they usually have maximum balance of $25k that can receive that rate, so I am contemplating opening a few. The only catch is they require a regular direct deposit (easy to do with a portion of your paycheck) and between 10-12 transactions with your debit card. I am not sure I can swing 20 debit transactions a month, so I am seeing how… Read more »

Steve
Steve
9 years ago

I don’t have a huge emergency fund yet, so I try to keep all of my money accessible within 24 hours. I’m working on that, but I also tend to make extra payments on loans because that has a better return than any of my savings accounts. I have about $500 in my primary credit union’s savings account earning 0.5%. I get 0.1% on the checking but it’s a free checking account with unlimited transactions. This is where I have my paycheck on direct deposit. I have another $800 or so in Wachovia’s Way2Save account, earning 5% for the first… Read more »

Cathy Moran
Cathy Moran
9 years ago

The important thing is not to use low returns on savings as an excuse not to save. It’s easy to get so focused on the negligible yield that you forget that the point is to have money available later, regardless of how much it grows before needed.

Kevin M
Kevin M
9 years ago

Our savings is at ING which I think is about 1.1% right now. It’s a pitiful return, but it’s safe and easy to access, which is key for an emergency.

I’ve heard of the 4% checking accounts but honestly I’m afraid to keep that much money in a checking account that is tied to a debit card in case it is lost.

Kat
Kat
9 years ago

We’ve got our emergency fund in Capital One online savings, which pays like 1.35% or 1.5% or something, plus a “bonus” every quarter. Otherwise, we’re focusing on paying off student loans (the highest interest rates first) pretty aggressively, and now that I’m eligible to contribute to my 401k, I’ve started doing that, albeit conservatively — as the year goes on I may consider trying to max out my 401k. (We’re trying to prepare for a baby and hopefully my quitting my day job to focus on my business (in the next 12 months), so money we can’t touch until we’re… Read more »

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