How to protect your savings as the Fed hikes interest rates

In an effort to reduce soaring inflation from the pandemic, the Federal Reserve is raising interest rates for the first time since 2018. The 0.25% rate hike announced March 16 comes as consumer prices have risen at their fastest pace in 40 years.

As a result, we may be entering a period of rising interest rates that we have not seen since 2006. Unlike 2006, today's inflation rate is much higher — and unfortunately, inflation is eroding the value of cash savings. Adding risky bets on stocks or bonds to reduce this erosion isn't suitable because savings are intended for emergencies and short-term goals. Still, there are steps to increase yield on your savings without adding risk.

Here are four ways to protect your savings that are especially helpful in today's challenging and highly unpredictable environment.

Move your savings account to an online bank

The easiest way to earn more on your savings is to move your savings account to an online bank. Online savings accounts have higher interest rates than savings accounts at brick-and-mortar banks, and their rates have a history of increasing faster in a rising interest rate environment.

The last period of rising rates occurred in 2017 and 2018. From December 2017 to December 2018, the Federal Reserve raised rates five times. In December 2017, the nationwide savings account average as documented by the Federal Deposit Insurance Corp. was 0.06%. The online savings account average was 1.29%, more than 21 times the nationwide average. After the federal funds rate reached its peak in December 2018, the nationwide average increased to 0.09% while the online savings account average increased to 2.21%, almost 25 times the nationwide average.

Today, the nationwide savings account average is 0.06%, and the online savings account average is 0.49%. Some of the best online savings account rates offered today are from Comenity Direct, the online division of Comenity Capital Bank (0.75%) and Ivy Bank, the online division of Cambridge Savings Bank (0.70%).

Make sure your online savings account remains competitive

If you already have an online savings account, make sure it doesn't lag as rates rise. During the pandemic, banks became flush with deposits while loan demand weakened. This resulted in banks lowering their deposit rates to record low levels. Many banks, even online banks, are not seeing their deposit and loan levels return to normal levels. Consequently, they will likely be slow to raise deposit rates. Don't assume your online savings account rate is remaining competitive: Compare its rate with others, and if it's lagging, move to a more competitive savings account.

Another tactic used by some online banks as rates rise is to create new online savings accounts with competitive rates while existing savings accounts have rates that remain low. The banks promote their new savings accounts to new customers while existing customers are earning less interest in the old savings accounts. Check your account statements to review the competitiveness of the interest rate that you are earning. If it's not competitive, contact your bank for other options. If they can't offer a competitive rate, move your funds to a higher-earning savings account.

Supplement your savings with Series I savings bonds

Even though you can earn more in an online savings account than in a savings account at a brick-and-mortar bank, the best online savings account rates don't come close to today's elevated inflation rate.

The only risk-free savings product that will keep up with inflation is the Series I savings bond (I bond), which is available from the U.S. Treasury via the TreasuryDirect website. The I bond rate is indexed with the Consumer Price Index (CPI). The I bond's yield includes a fixed rate that lasts for the duration of the I bond (up to 30 years). 

Added to the fixed rate is the inflation rate component that changes every six months from when the I bond is purchased. Every November and May, new I bond inflation rates, based on the CPI increase during the previous six months, are released. The current fixed rate is zero, so the total interest rate of today's I bond is equal to the inflation rate component — which is now 7.12% for I bonds purchased through April 2022. As you can see, online savings account rates aren't even close to today's I bond rate. That will likely continue for another six months starting in May.

I bonds can be used to boost the overall yield of your savings, but they aren't suitable for all of your savings for two reasons. First, the Treasury limits purchases of I bonds by an individual via the TreasuryDirect website to $10,000 per calendar year. Second, after you purchase an I bond, you can't access the funds for one year. After one year, you can redeem the I bond, but there's an early withdrawal penalty of three months of interest for the first five years after the purchase. Due to these two factors, you don't want to put all of your emergency fund into I bonds at one time. Instead, the saver should slowly build up their I bond holdings.

Yield and safety

The yield on your savings may not keep up with inflation, but steps can be taken to maximize yield without adding risk. That can keep your savings safe and liquid, so you can depend on those savings when emergencies arise or when you're ready to spend it on your short-term goals.

Ken Tumin is founder of DepositAccounts.com by LendingTree, which has been tracking and rating the savings, CD and checking account offerings of banks and credit unions for more than a decade.