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The Looming Challenge of Securing a 5% Return on Cash

The Looming Challenge of Securing a 5% Return on Cash

Interest rates have been favorable for investors in recent years. In January 2022, the federal funds rate was 0.08%. By April 19, 2024, it had risen to 5.33%. But what does the future hold for these rates, and how will it affect your savings?

### Understanding the Federal Funds Rate
The federal funds rate is the interest rate that banks or credit unions charge each other for overnight loans. This rate is determined by the Federal Open Market Committee (FOMC), commonly referred to as “the Fed.” The FOMC meets eight times a year to set the target rate, adjusting it to help the economy perform better. For instance, when inflation is high, the FOMC raises the interest rate to make borrowing more expensive, which in turn reduces spending and helps control inflation.

### Impact on Your Savings
While the FOMC doesn’t directly control the interest rates that banks pay on savings accounts or money market accounts, the competitive nature of the banking industry means that most banks adjust their rates in line with the Fed’s changes.

### Future Projections
The FOMC not only announces current rate changes but also provides guidance on future expectations. In January and March of this year, the Fed kept the interest rate unchanged after having raised it 11 times from March 2022 to July 2023 to combat inflation. In December 2023, the FOMC projected that the federal funds rate would decrease to 4.6% this year, a reduction of 0.73% from the current rate.

When the Fed lowers the rate, banks are likely to follow, meaning you might not earn 5% on your savings anymore. Although the exact timing of these cuts is uncertain, the Fed is expected to start soon and make gradual reductions to monitor the economy’s response.

Despite these changes, savings accounts will still offer better rates at the end of this year compared to 2022. Therefore, there’s no need for drastic actions, but be prepared for the possibility that the days of 5% interest on cash might be coming to an end by late 2024.