Combat Federal Reserve Interest Rate Hikes with FDIC-Insured High-Yield Savings Accounts

Highlights:

• High-yield savings accounts are a type of savings account with a higher-than-average annual percentage yield (APY). An APY measures how much you'll earn annually from an investment with compounding interest.
• Most standard savings accounts earn an APY of less than 1%. High-yield accounts, on the other hand, have APYs of anywhere from 1% to more than 5%.
• FDIC-insured high-yield savings accounts may help your hard-earned money keep pace with inflation better than it would in a traditional savings account.

When the Federal Reserve (the Fed) raises interest rates, everyone — from international corporations to everyday Americans — pays attention. Rate hikes are closely connected to the overall health of the economy, and even small increases can have wide-ranging negative consequences.

But higher interest rates may have one unexpected benefit: they can help your hard-earned money keep pace with inflation, especially if you have a high-yield savings account.

Why does the Fed raise interest rates?

The Fed was created as America's central bank in the early 20th century with the goal of regulating and maintaining the U.S. financial system. One of the chief ways the Fed accomplishes this goal is by raising or lowering the interest rates for loans made to banks and other financial institutions. Interest rate hikes occur in response to certain economic events, such as rising inflation.

Interest rates help control the flow of money into and out of the U.S. economy. When rates are up, money becomes more expensive to borrow. So, consumers and businesses may become less likely to spend money or access new loans. When interest rates are down, credit generally becomes more affordable to borrowers. During these periods, more people can access loans or make large purchases, which stimulates the economy.

The Fed usually raises rates to slow consumer spending during periods of inflation. However, rising interest rates aren't all bad news. Money-conscious savers may be able to take advantage of these increases through FDIC-insured high-yield savings accounts.

What are high-yield savings accounts?

High-yield savings accounts offer a higher-than-average annual percentage yield (APY). An APY measures how much you'll earn annually from an investment with compounding interest, which refers to the earnings that are periodically added back into your savings account. Most standard savings accounts earn an APY of less than 1%. High-yield accounts, on the other hand, have APYs of anywhere from 1% to more than 5%.

The APYs on these accounts can help you earn a higher return on your money than you would be able to with a traditional savings account. Keep in mind that the APYs on high-yield accounts are variable, meaning that they can shift up or down at any time. Although interest rates may fluctuate due to a number of factors, they typically keep pace with changes from the Fed.

High-yield savings accounts were developed by emerging online banks to compete with large banks and other long-established financial institutions. Although some traditional banks do offer savings accounts with higher rates of return, the best APYs are generally available from non-traditional sources — particularly online banks.

Are high-yield savings accounts from online banks safe?

Online banks are different from brick-and-mortar banks: they have no branches and may not offer certain standard financial services such as checking accounts, debit cards and notarization. However, in lieu of these features, online banks tend to offer high-yield savings accounts with competitive APYs. They are typically as secure as traditional banks — as long as they are FDIC-insured.

FDIC insurance provides automatic protection for up to $250,000 per depositor per institution for each covered category. These covered categories include savings and checking accounts, certificates of deposit (CDs) and money market accounts. Most online banks are FDIC-insured, so if they fail, you'll be compensated for your losses, provided you hold a covered account.

How to fight inflation with your high-yield savings account

High-yield savings accounts, coupled with an aggressive savings strategy, can help you battle against inflation while protecting your purchasing power. To really succeed, you'll need to save more and save smarter. Here's how:

• Identify new ways to save. How much of your monthly income goes into your savings account? Take a close look at your monthly budget and reduce or eliminate any unnecessary costs. For example, you might cut back on your entertainment expenses, sign up for cheaper internet and cellular plans, or even forego travel. Any money you save should be redirected to your savings account.
• Look for higher interest rates on savings accounts. If the interest rate on your savings account isn't higher than the rate of inflation, you risk losing the value of your dollar. If you're looking for a new account with an interest rate that can keep pace with rising inflation, consider high-yield savings accounts offered by traditional banks, credit unions and online banks. Make sure to compare APYs, which account for compounding interest.
• Research CD rates for an even higher yield. CDs are a special type of low-risk, high-earning account available from banks and credit unions. They typically have better rates than even high-yield savings accounts, but there's a catch: the money in your CD must sit undisturbed for a fixed period of time. However, CDs allow you to lock in an interest rate over this period, which works to your advantage if interest rates fall.

High-yield savings accounts can be a powerful tool to build your savings, even in the face of inflation. Careful saving in the right type of account can deliver benefits for months or even years into the future.