(4 minutes to read)
Interest rates haven’t been this high for about 15 years, since before the Great Recession in 2008–09. That means you can earn more interest on your cash, but it also means you might also be paying more interest on credit cards and variable interest rate loans, such as a home equity line of credit (HELOC). After a decade and a half of not having to think much about where to park your cash or proactively manage your debt, the time has returned. Cash management is back!
To fight high inflation, the US Federal Reserve has raised interest rates 11 times in the last year and a half, setting its key short-term interest rate target, the federal funds rate, to a range between 5.25% and 5.5%. Short-term interest rates have increased more than 5% since early 2022! Previously, the federal funds rate target range had been 0% to 0.25%, extending back to the start of the COVID-19 pandemic, and even much of the decade prior.
As a result of rising interest rates, brokerage account money market mutual funds are now paying 5% or more on an annual basis. For example, Fidelity Investment’s default money market fund (FDRXX) was paying 5.00% in late November, and its institutional money market fund (FMPXX) was yielding 5.33%. Bankrate.com is showing several online banks offering similar rates on high-yield savings and money market accounts.
Surprisingly, bank checking accounts are still paying next to nothing, if they’re paying any interest at all. In fact, many checking accounts still charge an annual fee—you pay them to leave your money there. Because of this, it can make a lot of sense (and cents) to hold the bulk of your extra cash in a money market fund or high-yield savings account, and transfer cash to your checking account as you need to use it. You can still access your money whenever you want, but when you park your cash in a brokerage money market fund or high-yielding bank savings account, you earn more interest while the cash sits.
Certificates of deposit (CDs), which also earn you more interest than a checking account, do have restrictions on when you take money out. CDs come with maturities, such as one month, three months, six months, one year, two years, or up to five years or more. With a CD, you lock your rate for the whole term. If rates go up, you don’t get to earn more, but if interest rates go down, you continue to earn the higher rate that you locked in. While the Federal Reserve isn’t likely to start reducing interest rates this year or early next year, at some point they’ll go down. And then the thought of having them locked in at earlier, higher interest rates on CDs could look very good. Remember though, with CDs you can’t take your money out until the end of the CD’s term without incurring a 10% penalty.
The flip side of earning higher interest on cash is having to pay higher interest on debt. Interest rates on credit cards have increased, along with short-term interest rates, giving you even more reason not to carry a balance. Interest rates on leading credit cards currently range from 18% to 30% per year—you don’t want to carry a balance with rates that high. At a 30% interest rate, your outstanding balance will double in about two and a half years. With rates this high, before you think of keeping cash in a money market fund earning 5%, you likely want to first funnel all available extra cash to paying down any credit debt you have. It’s the equivalent of earning 13% to 25% on your money.
The same applies to HELOCs, which typically have variable interest rates. Rates on HELOCs have increased recently to their current level of about 7% to 9%. Pay down your HELOC with any extra cash, even if it’s only for a few days, and then borrow it again if needed later. That way, you won’t be paying interest on that money when you don’t need it. This type of active debt and cash management didn’t make too much sense when HELOC interest rates were in the 2% to 4% range, but the extra effort might be worth it now.
With higher interest rates, things have changed. It’s time to again think through how these rates are helping you make or lose money. It’s time to consider interest earned and interest burned in your financial transactions.
Parkworth Wealth Management provides holistic wealth management services including financial planning, equity compensation planning, investment management, tax planning, and others, on a fee-only basis and as a fiduciary, acting in clients’ best interests. If you would like help earning more on your cash or better managing your debt to build wealth faster, schedule a complimentary consultation.
