How the drop in interest rates to almost zero affects checking and savings accounts, CDs, and money market funds.
As we’re emerging from the initial shock of the COVID-19 pandemic and the stock market crash that accompanied the crisis, investors are re-evaluating how their portfolios are being affected.
In particular, the Federal Reserve’s announcement of dropping its benchmark interest rate to zero as a strategy to support the flow of credit to households and businesses will have a significant impact on your savings and investments.
Also called the base interest rate, the benchmark interest rate is the minimum interest rate that investors will demand when investing in non-Treasury securities.
Although cutting interest rates has historically been a successful tactic in the Fed’s tool kit to encourage spending, we face a unique challenge today because interest rates were already at historic lows. As such, many savings options offered by U.S. banks were already not yielding enough to offset inflation, even before the crash.
Meanwhile, the projection for the inflation rate for the rest of the year is still in flux. Before the market crash, the inflation rate was hovering around 2.3%. After the coronavirus hit, the price of some products has skyrocketed, while others have gone down. While the verdict is still out on how the overall inflation rate will be affected, investors need to remember that if the interest rate on savings accounts is lower than the inflation rate, then their spending power will diminish.
How Passive Income Yields Are Affected by the Federal Rate Cut
If you have been putting your money in traditional and online banks savings accounts, CDs, and/or money market funds to yield passive income, you may be wondering how the drop of the benchmark interest rate to almost zero will impact your finances. Here’s what you need to know:
Checking and Savings Accounts with Traditional/Retail Banks
According to the FDIC, the average savings account rate has been hovering below 0.09% at some of the largest retail banks.
Most national banks offer a 0.01% APY on basic savings accounts. You may be able to find a better rate with a higher balance, but it rarely goes above 0.10% APY.
Some banks offer higher rates if you link your checking and savings accounts. For example, Chase Bank offers Relationship APYs that range from 0.02% to 0.05%, compared to the standard APY of 0.01%.
While having some money in these checking or savings accounts is essential for maintaining liquidity, the extremely low interest rate means you’re not even close to beating inflation, and your spending power will decrease over time.
Checking and Savings Accounts with Online Banks
Online banks typically pay 10-20 times the interest rate compared to retail/brick-and-mortar banks, thanks to lower overhead expenses.
As of April 2, 2020, the highest rate is from Prime Alliance Bank at 1.96% APY with a $10,000 minimum balance—more than 20X the national average of 0.07%.
While online accounts are good options for longer-term cash savings, they will still have a challenging time beating inflation in the current economic environment.
CDs and Money Market Funds
These are among the safest investment options available, especially for investors who have a low risk tolerance, are nearing retirement, or are retirees who don’t need immediate income.
Certificates of deposit, or CDs, have specific maturity dates that can range from several weeks to several years. Money market accounts typically yield less interest but require a lower minimum balance.
CDs are offered by banks and credit unions. The interest rates vary depending on the financial institute and the maturity date. As of April 2, 2020, the interest rates of CDs ranged from 0.05% APY to 1.90% APY depending on the maturity date. Meanwhile, interest rates for money market funds hovered between 1.50% to 1.80% APY.
When you invest in CD or MMF, you’re subject to interest rate fluctuations. If the interest rate dips below the inflation rate, your purchasing power will once again diminish.
High-Yield Investment Alternatives
The main reason that the Federal Reserve cuts interest rates now is to stabilize the economy during the current financial crisis.
For the Fed to raise the interest rate again, the economy needs to pick up and investors need to show confidence in the U.S. market. Given the current situation with the COVID-19 pandemic, as well as the resulting high unemployment rate, disrupted business revenues, and negative economic growth, it’s highly likely that interest rates will remain low for a long time.
For alternative investment vehicles that can generate high returns, investors should consider overseas opportunities that offer the right mix of risk, yield, growth potential, and time horizon. This is especially true for travel, as the industry has historically recovered in record time.
These are two of our most popular passive-income opportunities available:
- Casa do Cativo, an already operating cash-flowing boutique hotel in Porto, Portugal with a projected ROI of 7%
- A beachfront hotel project in Puerto Rico with a forecasted IRR of 16-19% located in a Qualified Opportunity Zone, which means returns can be even higher for investors with capital gains
If you are interested in higher passive-income returns in a low interest rate environment, please enter your contact information below and someone from our investment team will be in touch.
Subscribe to our newsletter and stay up-to-date on new investment opportunities and residential properties for sale, exclusive investor travel packages and conferences, and special rental discounts.