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Jordan Goodman is the author of Everyone's Money Book, available at 888-201-6300. This is the third edition of the book. You can also visit his Web site at www.moneyanswers.com. He talks with us on Thursday mornings.
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July 3, 2003
"The Effect of the Fed’s Rate Cuts"
The recent cut by the Federal Reserve of its Fed Funds and Discount Rates to
1%, the lowest since 1958, is designed to stimulate the economy. But
depending on whether you are a saver or borrower, it may actually end up
doing more harm than good. Here is a quick look at the winners and losers
from this latest rate cut:
SAVERS
Savers have already been hurt by previous rate cuts, and now, their pathetic
yields are going to shrivel to almost nothing. The average money market
mutual fund now yields 0.64%, and that will probably drop to about 0.4% in
coming weeks. In many cases, money fund management fees of 0.5% or higher
are actually more than the portfolio is yielding, meaning many funds will
start to cost shareholders money, instead of earning them anything. Expect to
see many money funds merge or go out of business rather than lower their
management fees.
CD yields now pay about 1% for a 1-year maturity, and as much as 2.5% for a
5-year maturity. Expect CD yields to fall below 1% in coming months, and
5-year CDs to fall to about 2%.
Bank savings accounts mostly yield 2% or less, but in many cases, do
offer slightly higher yields than money market mutual funds. Bank rates
will typically also fall to 1% or less.
So, what is a poor saver to do? Take a look at short-term bond funds -- now
yielding over 5% -- which though not guaranteed, do offer great safety,
complete liquidity and significantly higher yields. All the major no-load
fund companies, like T. Rowe Price, Strong, Fidelity and Vanguard, offer them.
BORROWERS
The Fed rate cuts are designed to give borrowers a better deal, and
stimulate spending and borrowing -- but it doesn’t always work out that way:
Credit card rates from most major issuers hit their minimum interest rates
of 8% to 10% over 2 years ago, and they aren’t going down anymore, no matter
what the Fed does. Sure, there are plenty of offers for 0% or 2.9% for 6 months, but those jump back up to 8% or more after the teaser rate period expires. And, if you pay your bill one day late, the rate jumps up to over 20% right away. The solution: Go with a credit card with a permanently low
rate, particularly those in Arkansas with low usury ceilings where you can
get rates of 4% to 5%. (I have put a list of these banks together in my Credit
Card Optimizer Kit at www.moneyanswers.com).
Mortgage rates may drop further from already historically low levels, and
that will help the booming housing sector. But right after the Fed cut
rates, long-term rates actually soared, so it is not clear if mortgage rates
have much further to fall. Still, if your current mortgage is over 7% and
you have good credit, it will pay to refinance. You can always look into an
Automatic Rate Cut (ARC) loan at www.arcloan.com, where the rate only falls
and never rises.
Home equity rates will probably fall a bit more because they are tied to
the prime rate, which has fallen to 4%. Expect HEL rates to fall to an
average of 4.75%, from 5% or higher.
Car loan rates might fall a bit more, but it is hard to see car loans
falling from 0%. But if you get a regular car loan tied to the prime, your
rate might be a quarter point less.
Overall, the Fed’s rate cut might help a few borrowers, but clearly, it will
make savings an even more painful and unrewarding activity.
For More Financial Tips From Jordan Goodman
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