Recently, the Federal Reserve lowered the target range for the federal funds rate. This decision affects most consumer interest rates, so it’s normal to wonder what this change might mean for you. In this post, we’ll explain what interest rate decreases mean for your money and how you can make the most of your savings in a decreasing interest rate environment.

What to do with your short-term savings when interest rates decrease

When the federal funds rate decreases, the interest you earn on your short-term savings in a bank account (like a savings or checking account) or a high-yield account (like the Wealthfront Cash Account) will generally go down, too. This means your cash probably won’t earn as much interest as it used to.

This is a great reason—and opportunity—to review your finances and check that you’re not holding too much cash. As a general rule of thumb, we suggest you hold enough cash to cover the following items:

  • A good emergency fund (for most people, this is between 3-6 months’ worth of expenses)
  • Your regular monthly expenses (bills, groceries, etc)

Even when interest rates are relatively high, you are likely better off investing your excess savings (which we define as any savings beyond the items listed above) than keeping them in cash and earning interest. This is because your savings are much more likely to keep up with inflation if you invest them—particularly after you account for taxes.

When interest rates are falling, it’s also a good time to reevaluate where you keep your cash. Ideally, you would keep your cash at an institution you trust to pay you a competitive APY in both high- and low-interest rate environments. To determine this, look for institutions with a history of passing along a large proportion of past rate increases and of lowering their APY at a pace in line with decreases in the fed funds rate. Some institutions will be slow to match increases in the fed funds rate and cut rates much faster as the fed funds rate falls—we think they do this because it’s good for their bottom line and they feel clients are unlikely to move their deposits elsewhere. But at Wealthfront, we navigate relationships with our partner banks so you can benefit from a competitive APY on your Cash Account deposits whether rates are going up or down.

What to do with your extra cash when interest rates decrease

Maybe you have extra cash left over after accounting for your regular expenses, bills, and emergencies but you aren’t ready to invest it for the long term or take on much risk (perhaps because you have it earmarked for an important future expense).  If that sounds like you, you might consider investing that extra cash in a portfolio of US Treasuries like Wealthfront’s Automated Bond Ladder—particularly if you expect interest rates to fall further. Our Automated Bond Ladder helps you take advantage of current yields with very little risk to your principal because US Treasuries are backed by the full faith and credit of the US government. And because interest from Treasuries is exempt from state and local income taxes, you can keep more of what you earn than you would with most savings accounts and CDs. To understand how much you personally could benefit from the tax treatment of Treasuries, enter your details into our calculator.

Automated Bond Ladders can be especially appealing if you expect interest rates to continue falling. That’s because the interest rate you earn on a bond is determined at the time the bond is purchased—so even if interest rates fall and new bonds have lower interest rates, you’ll keep earning the original yield on bonds you already own until maturity (assuming you don’t sell). This is why people sometimes say bonds allow you to “lock in” current interest rates.

What to do with your long-term savings when interest rates decrease

When it comes to your long-term savings (which we define as savings you don’t plan to spend for at least three to five years), changes in interest rates shouldn’t necessarily affect your strategy. History shows that changing your investment strategy because interest rates are above or below a certain threshold is unlikely to work out in your favor. 

Instead, we suggest sticking with a diversified portfolio of low-cost index funds that is appropriate for your personal risk tolerance (like what you get with Wealthfront’s Automated Investing Account) and taking advantage of tax-loss harvesting (which Wealthfront automates and offers at no extra cost).

Key takeaways

When interest rates change, it’s normal to wonder if you should change the way you approach your finances. To make the most of your money when interest rates decrease, we think you should do the following:

  • For your short-term savings: Make sure you’re not holding too much cash, and if you are, consider investing the excess. Ensure you’re keeping your cash with an institution you trust to pay you a competitive APY in all interest rate environments. (We suggest the Wealthfront Cash Account, which currently has a 4.50% APY.)
  • For your extra cash: For extra cash that you aren’t ready to invest for the long term, you might consider US Treasuries. Wealthfront’s Automated Bond Ladder makes it easy to benefit from Treasuries’ higher yields, and can also help you “lock in” current interest rates if you expect rates to fall further.
  • For your long-term savings: Stay the course. We suggest keeping your long-term savings in a diversified portfolio of low-cost index funds like a Wealthfront Automated Investing Account. Avoid the temptation to modify your long-term investment strategy based on interest rate changes.

A final note: When the federal fund rate decreases, it’s true that you’ll probably earn less interest on your cash. But there’s a silver lining to lower rates: Borrowing should get less expensive, too. This is good news if you’ve been thinking about taking out a mortgage, and it’s also good news if you decide to borrow against your taxable Automated Investing Account with a Wealthfront Portfolio Line of Credit (which you can use to borrow up to 30% of the value of your taxable Automated Investing Account with no credit check, no application fee, and no repayment schedule).

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The information contained in this communication is provided for general informational purposes only, and should not be construed as investment advice. Nothing in this communication should be construed as an offer, recommendation, or solicitation to buy or sell any security. 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.

Cash Account is offered by Wealthfront Brokerage LLC (“Wealthfront Brokerage”), a Member of FINRA/SIPC. Neither Wealthfront Brokerage nor any of its affiliates are a bank, and Cash Account is not a checking or savings account. We convey funds to partner banks who accept and maintain deposits, provide the interest rate, and provide FDIC insurance. Investment management and advisory services–which are not FDIC insured–are provided by Wealthfront Advisers LLC (“Wealthfront Advisers”), an SEC-registered investment adviser, and financial planning tools are provided by Wealthfront Software LLC (“Wealthfront”).

The Annual Percentage Yield (APY) for the Cash Account is as of September 27, 2024, and may change at any time, before or after the Cash Account is opened. The APY for the Wealthfront Cash Account represents the weighted average of the APY on the aggregate deposit balances of all clients at the program banks. Deposit balances are not allocated equally among the participating program banks.

Investing in U.S. Treasuries involves risks, including but not limited to interest rate risk, credit risk, and market risk. While U.S. Treasuries are considered to be among the safest investments, they are not entirely risk-free, and there is a potential for loss of principal. Returns on U.S. Treasuries can also be affected by changes in the credit rating of the U.S. government, although such occurrences are rare. Investors should consider their tolerance for these risks and their overall investment objectives before investing in U.S. Treasuries. Past performance does not guarantee future results.

The yield earned from U.S. Treasuries is exempt from state and local income taxes. However, interest income from Treasuries is subject to federal income tax. Tax treatment may vary depending on your individual circumstances. To understand implications for your specific financial situation, consult with a tax professional.

Wealthfront Advisers and its affiliates do not provide legal or tax advice and do not assume any liability for the tax consequences of any client transaction. Clients should consult with their personal tax advisors regarding the tax consequences of investing with Wealthfront Advisers and engaging in these tax strategies, based on their particular circumstances. Clients and their personal tax advisors are responsible for how the transactions conducted in an account are reported to the IRS or any other taxing authority on the investor’s personal tax returns. Wealthfront Advisers assumes no responsibility for the tax consequences to any investor of any transaction.

Investment advisory services are provided by Wealthfront Advisors, an SEC-registered investment adviser, and brokerage products and services are provided by Wealthfront Brokerage LLC, member FINRA / SIPC. 

The effectiveness of the tax-loss harvesting strategy to reduce the tax liability of the client will depend on the client’s entire tax and investment profile, including purchases and dispositions in a client’s (or client’s spouse’s) accounts outside of Wealthfront Advisers and type of investments (e.g., taxable or nontaxable) or holding period (e.g., short-term or long-term).

Wealthfront Advisers’ investment strategies, including portfolio rebalancing and tax loss harvesting, can lead to high levels of trading. High levels of trading could result in (a) bid-ask spread expense; (b) trade executions that may occur at prices beyond the bid ask spread (if quantity demanded exceeds quantity available at the bid or ask); (c) trading that may adversely move prices, such that subsequent transactions occur at worse prices; (d) trading that may disqualify some dividends from qualified dividend treatment; (e) unfulfilled orders or portfolio drift, in the event that markets are disorderly or trading halts altogether; and (f) unforeseen trading errors. The performance of the new securities purchased through the tax-loss harvesting service may be better or worse than the performance of the securities that are sold for tax-loss harvesting purposes.

Tax loss harvesting may generate a higher number of trades due to attempts to capture losses. There is a chance that trading attributed to tax loss harvesting may create capital gains and wash sales and could be subject to higher transaction costs and market impacts. In addition, tax loss harvesting strategies may produce losses, which may not be offset by sufficient gains in the account and may be limited to a $3,000 deduction against income. The utilization of losses harvested through the strategy will depend upon the recognition of capital gains in the same or a future tax period, and in addition may be subject to limitations under applicable tax laws, e.g., if there are insufficient realized gains in the tax period, the use of harvested losses may be limited to a $3,000 deduction against income and distributions. Losses harvested through the strategy that are not utilized in the tax period when recognized (e.g., because of insufficient capital gains and/or significant capital loss carryforwards), generally may be carried forward to offset future capital gains, if any.

Wealthfront Advisers and its affiliates do not provide legal or tax advice and do not assume any liability for the tax consequences of any client transaction. Clients should consult with their personal tax advisors regarding the tax consequences of investing with Wealthfront Advisers and engaging in these tax strategies, based on their particular circumstances. Clients and their personal tax advisors are responsible for how the transactions conducted in an account are reported to the IRS or any other taxing authority on the investor’s personal tax returns. Wealthfront Advisers assumes no responsibility for the tax consequences to any investor of any transaction.

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About the author(s)

Alex Michalka, Ph.D, has led Wealthfront’s investment research team since 2019. Prior to Wealthfront, Alex held quantitative research positions at AQR Capital Management and The Climate Corporation. Alex holds a B.A. in Applied Mathematics from the University of California, Berkeley, and a Ph.D. in Operations Research from Columbia University.