With the Fed Raising Interest Rates by 0.50%, Should You Put More Money Into Savings?

The answer may surprise you.

On Wednesday, May 4, 2022, the Federal Reserve raised the federal funds rate by the most since 2000.

In an ongoing effort to combat decades-high inflation, the Federal Reserve raised rates by half of a percentage point. This followed an earlier rate increase in mid-March and the benchmark rate is now 0.75% to 1.00%, up from near 0% during the heart of the COVID-19 pandemic.

With the federal funds rate increasing, banks are expected to raise the interest rates on savings accounts. But does this mean you should put more money into savings?

Do higher savings account rates justify larger investments?

When the Fed raised rates by 25 basis points in mid-March, it had an undeniable impact on savings account rates. Specifically, the average yield offered by high-yield online savings accounts rose four basis points. Since the rate increase is more substantial this time, it's likely that the APY on savings accounts will also go up a little more than after the last rate increase as well.

However, even after savings accounts jumped up after the last rate increase, average yields were still only at 0.54%. Needless to say, this means you will not see a very impressive ROI on any money you put into savings.

Unfortunately, the Fed has been pushed into raising rates in order to combat record-high inflation. Prices climbed by 8.5% year-over-year through March 2022, which meant goods and services cost substantially more this past March than they did the prior year.

With inflation at 8.5% and typical savings account yields still well below 1%, any money you have in savings isn't keeping pace with rising prices and its buying power is eroding. This won't change, even with rates going up.

As a result, increasing the amount you invest in savings accounts makes little sense just because rates will go up slightly.

The amount you have in savings should be dictated by your financial goals

Ultimately, you should not be putting money into a savings account because of the returns you can earn. Money should be put into savings because you need the cash to be in a liquid state and a risk-free investment.

It's important to keep certain types of cash in savings. For example, you want your emergency fund money to be in a savings account so you can access it easily when you need it. And if you are saving money you will need within the next few years, it should also be in savings. That way, you can access it when you need it without having to worry about trying to time your withdrawals based on economic conditions.

The amount of money you'll need for emergency savings and for these short-term financial goals is dictated by your financial objectives. In other words, it's a good idea to have three to six months’ worth of expenses in an emergency account. And if you need to save for a down payment to buy a house in two years, you'll want to put as much into your account as you need to put down on the property.

Any money you're hoping to invest for long-term goals, however, should be in the stock market or in other assets that have a chance of producing much higher returns than a savings account. And that doesn't change just because savings account rates rise slightly.

You should still keep exactly as much money in savings as you need for short-term and mid-range financial goals. Put the rest into the market where you can hopefully earn the type of returns that won’t just keep pace with inflation, but also enable you to build wealth.