How the Fed Funds Rate Impacts the Wealthfront Cash Account

You may not think about it very often, but the federal funds rate (or “fed funds rate” for short) almost certainly has an impact on your life. It’s an important factor in the interest you earn on your savings as well as the rate you pay on any loans or debt. The fed funds rate influences nearly every financial institution (including Wealthfront!), and a rate increase or decrease directly impacts consumers. In this post, we’ll explain what the fed funds rate is, how the fed funds rate is set, and what it means for your Wealthfront Cash Account. 

What is the federal funds rate?

Let’s start with the basics. The federal funds rate is the rate at which banks lend money to each other, and it’s the basis for most consumer interest rates. This rate is expressed as a target range, and it is set by the Fed at Federal Open Market Committee (FOMC) meetings, which are held eight times each year. 

When the Fed raises the fed funds rate, the interest rates on loans like mortgages tend to go up (which is bad for consumers) but the interest rates paid to consumers with high-yield accounts and certificates of deposit (CDs) also tend to go up (which is good for consumers). The converse is also true. When the fed funds rate decreases, loans tend to be less expensive but you are also likely to earn less interest on your savings—including the money you keep in your Wealthfront Cash Account. 

How the Fed determines the federal funds rate

The Fed uses the fed funds rate as a way of smoothing out economic performance. In setting the fed fund rate, the Fed considers factors related to its “dual mandate”—maintaining strong employment and keeping inflation in check. Generally, the Fed targets higher rates when it is concerned the economy is growing too quickly (which may lead to inflation), and it lowers rates when the economy is slowing down. The premise behind these moves is that lower interest rates encourage companies to borrow, which fuels growth. On the other hand, more expensive credit discourages borrowing, which slows growth.

For example, during the early days of the COVID-19 pandemic, the Fed lowered the target range for the fed funds rate sharply until it was 0.00-0.25% in an attempt to keep the US economy from slowing down too much. The Fed then kept rates low until early 2022 when high inflation readings (well over the Fed’s 2% target) led the Fed to start increasing interest rates again. In the period that followed, the Fed increased the target range for the federal funds rate 11 times, and rates rose to their highest level in 22 years (a target range of 5.25% – 5.50%) in an effort to combat inflation. 

How a rate change could impact Wealthfront clients

The APY on the Wealthfront Cash Account is largely determined by the fed funds rate. As a result, when the Fed raises the fed funds rate, the APY on the Wealthfront Cash Account goes up, too. In 2022 and 2023, as the Fed aggressively raised rates in an attempt to curb inflation, Wealthfront was delighted to pass along those increases to you in the form of a higher Cash Account APY. 

But what happens if the Fed lowers their target range for the fed funds rate? Unfortunately, if the Fed lowers the fed funds rate, then we will have to lower the rate for our Cash Account by a similar amount (and we expect other financial institutions to do the same). Rest assured that even in this scenario, we will keep working with our partner banks to ensure we are offering you an industry-leading APY that’s among the highest on the market. 

It’s worth noting that not all financial institutions will react to fed funds rate changes in exactly the same way. Keep in mind that banks make money by lending out your deposits. The less of that money they share with you in the form of interest on your accounts, the more they get to keep. We suggest keeping your savings with an institution that has a history of passing along a high percentage of fed funds rate increases to you in the form of a high APY. If you find an institution you trust to do this, it’s more likely they will also avoid unnecessarily cutting their APYs in a falling rate environment, so you can earn more on your cash even when rates are falling overall. At Wealthfront, this is baked into our mission: We’re building a financial system that favors people, not institutions. That means sharing more interest with you instead of keeping it all for ourselves.

Key takeaways

To recap, here’s what you should keep in mind about the fed funds rate and how it impacts the Wealthfront Cash Account:

• The fed funds rate is the rate at which banks lend money to each other, and it is the basis for most consumer interest rates.
• When the fed funds rate goes up, your Cash Account APY will generally go up by a similar amount.
• When the fed funds rate goes down, your Cash Account APY will generally go down by a similar amount.
• It’s smart to keep your savings with an institution you trust to pay you a fair APY in a variety of interest rate environments.

Whether interest rates are rising or falling, we’ve built the Wealthfront Cash Account to be the ideal home for money until you’re ready to invest. We currently offer a high 4.25% APY and up to $8 million FDIC insurance through our partner banks, along with zero account fees, free same-day withdrawals, free wires, access to a debit card and 19,000+ free ATMS, and the ability to invest within minutes. You can also pay bills, send checks, and even use the Cash Account with your favorite payment apps like Venmo, CashApp, Apple Pay, Google Pay, and PayPal.