Note: As of December 16, 2022, the Wealthfront Cash Account has a 3.80% APY. Read more about it here .
Last week, the Federal Reserve surprised most people by saying it was considering decreasing the federal funds rate (the interest rate at which banks lend money to each other, and the basis for most consumer interest rates). The announcement came as a surprise because as recently as a month ago, the Chairman of the Fed, Jerome Powell, said he saw no reason to change rates.
The fed funds rate influences nearly every financial institution, and a rate decrease directly impacts consumers. The good news: when the rate goes down, mortgage rates go down. The bad news: high yield savings account rates and Certificate of Deposit (CD) rates go down, too. Unfortunately that includes Wealthfront cash accounts as well.
How the Fed determines the target federal funds rate
The Fed uses the fed funds rate as a way of smoothing out economic performance. Jerome Powell made the surprise announcement last week because he and his fellow Fed Board of Governors were worried that current (China) and potential (Mexico) trade wars could have a damaging effect on the economy. The Fed targets higher rates when it is concerned the economy is overheating (which may lead to inflation), and it lowers rates when the economy is slowing down as a way to maintain growth. The premise behind these moves is that cheaper credit encourages companies to borrow, which fuels growth. More expensive credit discourages borrowing, which slows growth.
During the financial crisis from 2007-2008, the Fed lowered its target fed funds rate from 5.25% to a range of 0.00–0.25%. It effectively couldn’t lower its rate any further, which meant it had very few tools remaining to enhance economic growth. As the economy recovered over the past 10 years, the Fed raised its target rate to the current 2.5%. There are some pundits that encourage the Fed to raise its rates even higher so it has more room to drop rates during a bad economy. The Fed does not agree with this philosophy.
How a rate decrease could impact Wealthfront clients
The Fed provides a target range for the fed funds rate, and the actual rate changes based on daily demand and supply of borrowing needs among banks. Over the past three months, for example, the Fed funds rate has varied from 2.37% to 2.45% (source).
When the daily fed funds rate increases within the range to a higher steady rate, Wealthfront’s Program Banks — the banks where we place your cash account funds — raise their wholesale rates, which we then pass along to you. That was how we first increased our rate from 2.24% to 2.29% APY one month after introducing our cash accounts. We then decided to raise the interest rate again, to 2.51% APY, based on our fundamental belief that your money should be making money for you, not for your bank. Passing more on to our clients is in our company DNA.
This blog is powered by Wealthfront Software LLC (“Wealthfront”) and has been prepared solely for informational purposes only. Nothing in this communication should be construed as an offer, recommendation, or solicitation to buy or sell any security or a financial product. Any links provided to other server sites are offered as a matter of convenience and are not intended to imply that Wealthfront Advisers or its affiliates endorses, sponsors, promotes and/or is affiliated with the owners of or participants in those sites, or endorses any information contained on those sites, unless expressly stated otherwise.
The APY may change at any time, before or after the Cash Account is opened. The Cash Account is offered by Wealthfront Brokerage LLC (“Wealthfront Brokerage”), a member of FINRA/SIPC. Neither Wealthfront Brokerage nor its affiliates is a bank.
Investment management and advisory services are provided by Wealthfront Advisers LLC, an SEC registered investment adviser, and brokerage related products, including the cash account, are provided by Wealthfront Brokerage, a member of FINRA/SIPC. Wealthfront Software LLC (“Wealthfront”) offers a free software-based financial advice engine that delivers automated financial planning tools to help users achieve better outcomes.
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About the author(s)
Andy Rachleff is Wealthfront's co-founder and Executive Chairman. He serves as a member of the board of trustees and chairman of the endowment investment committee for University of Pennsylvania and as a member of the faculty at Stanford Graduate School of Business, where he teaches courses on technology entrepreneurship. Prior to Wealthfront, Andy co-founded and was general partner of Benchmark Capital, where he was responsible for investing in a number of successful companies including Equinix, Juniper Networks, and Opsware. He also spent ten years as a general partner with Merrill, Pickard, Anderson & Eyre (MPAE). Andy earned his BS from University of Pennsylvania and his MBA from Stanford Graduate School of Business. View all posts by Andy Rachleff