How Does An Increase In Interest Rates Affect Your Savings?

Here’s the billion dollar question: should the fact that interest rates are now low affect the size of your emergency fund?

In a word: no.

Interest rates shouldn’t be the primary factor driving your decision to fund an emergency reserve. Your primary goal is safety. Like a storm cellar in Kansas, your emergency fund is a way to escape when disaster strikes.

That said, when interest rates are low, you might need to grab some creativity.


How Do I Tweak Rates?


Let’s begin with how you DON’T tweak.

In the past year I’ve read about investing instead in bonds, real estate and gold. I’ve even read that emergency funds are ridiculous because you can just take out a loan if you keep good credit. Take out a loan? How will you pay that back if you have no income? Of course emergency funds are ridiculous. So is a toilet. Why wouldn’t you just go in the trash? On second thought, I’ll keep both my reserve and my urinal.

Here are some better methods to reach for higher rates without affecting your security:

1) Compare interest rates at banks. Choose best fixed term savings accounts or money markets available from trusted banks. If the bank offers mobile banking options, and you can freely remove cash, it doesn’t matter where the brick and mortar bank is located. Your cash reserve isn’t your daily expense account, so you won’t need access to funds often.

2) Find CDs to ladder. As a second tier, take a portion of your cash reserve and stagger CDs. Purchase a 3 month, 6 month, 9 month and 12 month CD, for example. CDs may be a great choice because a timed deposit often earns a higher return if you promise to lock your money away longer. Even though the 12 month CD pays a higher rate, don’t choose just one. If you need the money, you’ll have to break the CD, losing interest and incurring penalties. Instead, when the 3 mos. CD comes due, transfer it to a 12 month CD, then when the 6 mos. CD matures, do the same. If you don’t end up using the month, you’ll have four one year CDs, a portion of which matures every quarter.

How much money should you move to CDs? Imagine the biggest check you’d ever write in an emergency. Maybe $1,000? Double that amount to leave in your “first tier reserve” (savings account or money market). Stagger the rest in a collection of CDs.

3) Schedule quarterly reviews. Interest rates change often. Providers such as Birmingham Midshires change rates often to stay competitive. Especially in low interest rate environments, you should be vigilant of news that might help you gain a higher rate.


Don’t Abandon Your Bank Account!


The worst mistake you could make as interest rates plummet is to lower the amount of your emergency fund. Some assets ARE about returns, cash reserves aren’t. Your job is about returns. Your portfolio is about returns. Your emergency fund is only about safety. Because you have this net, you can aggressively pursue strategies to increase your income and flex your investment muscles.

Photo credit: HowardLake

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Author: Average Joe

A 16 year veteran of the financial planning and financial media circus. Lover of hamburgers and ice cream.

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  1. Personally, I like having a hefty emergency fund for peace of mind. Low interest rates are tough on savers, but they are temporary. And low interest rates have their advantages if you’re a borrower.
    Barbara Friedberg recently posted..HOW TO RENT AN APARTMENTMy Profile

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  2. I understand the concept of CD ladders but (from what I’ve seen) going for less than 12 months wouldn’t make sense. In this disaster of a market, many savings accounts are paying more interest than the short-term CDs. I’m surprised a lot of people are still hesitant to move money to an online savings (even though the rate is nearly doubled).

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    • I’d argue exactly the opposite (fun!). Remember that your goal is liquidity, not interest rate. I have investments that will propel the portfolio. If I go longer than 12 mos, how long is it going to take me to make sure I keep 3 mos. stagger and get there? Plus, if I’m going two or three years why am I not looking at gov’t bonds? There’s zero reason that I can think of (now given, it’s the weekend and I just got home from Frankenweenie, so I might be missing something) to ever stagger longer than 12 mos. We want to top off interest rates, not lose liquidity.

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      • I can give you a reason. Does the term of a CD affect liquidity? In most cases, I would argue it doesn’t.

        So, why not 5 yr CD’s with a bank who has low penalty for getting out early? My 5 yr CD’s are much further ahead even if I break them than a 1 yr CD. Still, very liquid, couple clicks of a mouse and a few days later.

        I can tell you why not to go gov’t bonds, CPI-U is out tomorrow, my money is on the rate of new i-bonds being less than 1%.

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        • There you go. Sweet. If the penalty is low enough, sign me up. I knew there had to be one. ;-)

          Great point.

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    • Agreed, Brent. Agreed.

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  3. You see, I have never been able to understand why people fixate on something and as a result get all ense wrong. Couldn’t agree more: cash reserves have an entirely different purpose. The only situation in which we ought to concider the wisdom of having savings is in hyper-inflation – if your life savings are likely to buy you an ice-cream in a week time you should be worries. Not before then…

    I will also keep both my reserves and my toilet!
    maria@moneyprinciple recently posted..How has the eurozone crisis affected corporate banking?My Profile

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  4. Interest rates shouldn’t affect the size of your emergency fund, but it may affect where you keep it!

    Regardless of where and at what rate, protection of principle and liquidity are the priority – an emergency fund is useless if it loses value or you cannot get to the money when you need it!
    Joe Morgan recently posted..The Worst Things For Your Credit Score.My Profile

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    • Amen, Joe! Amen.

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