Current interest rates are slowly rising back to historical norms after years of near-zero levels. As they rise, consider how changing interest rates will affect your finances. Simply put, savers benefit from high interest rates and borrowers don’t.
Explore strategies that will enable you to profit from rising rates, whether you’re a borrower, lender or investor. Believe it or not, rising interest rates might improve your finances.
Why Are Interest Rates Rising?
The Federal Reserve Bank is in charge of the federal interest rate — or fed funds rate, as it is commonly called — which is the overnight interest rate banks charge for short-term loans. The government uses the overnight interest rate — as part of its monetary policy tool kit — to stabilize employment and inflation. The Fed meeting, chaired by Janet Yellen, occurs several times a year for attendees to decide what the interest rate and other monetary policies will be.
The fed funds rate has hovered near zero since 2008 when the Fed attempted to bring the country out of the recession. In June 2017, the rate rose for the third time since the recession.
The fed funds rate directly or indirectly influences many other interest rates in our economy — if you borrow or lend. Here are the rates it affects:
- Bank deposit rates
- Mortgage refinance rates
- Credit card rates
- Car loans rates
- Money market account rates
- Bond interest rates
Rising Interest Rates Strategies for Borrowers
If you’re in the market for a new home or condo you’ll naturally try to find the best mortgage rates. Because mortgage rates today are likely lower than they will be after another rate hike or two, if you have a sufficient income and down payment, it might be a good time to buy. Check today’s mortgage rates, get bids from several lenders and take the plunge on your new digs.
When interest rates rise, it’s likely to impact your credit card balance, and you can mitigate this in two ways. You can pay off your balance every month — and not worry about the interest rate — or transfer your balance to a lower-rate card or a card with a no-interest introductory period.
Rising Interest Rates Strategies for Savers
Savers have been waiting a long time for a bump in interest rates. After a rate hike, rates for savers rise more slowly than for borrowers. One good way to take advantage of rising rates is to build a CD ladder and profit from the expected upcoming rate increases. Another CD strategy is to invest in a bump-up CD, which enables you to increase your interest rate as market rates rise.
Instead of keeping your cash in the bank, you might consider a money market mutual fund. You can find this type of account with Schwab, Fidelity, E-Trade or other investment account provider. Similar to a bank money market account, interest rates on a money market mutual fund tend to rise with interest rates.
Rising Interest Rates Strategies for Investors
When you buy a bond or bond fund, you’re lending money to a company in exchange for interest payments. As interest rates rise, the coupon or interest payment for a new bond will also go up, which is good. Existing bonds or bond fund values, however, will drop as interest rates rise because investors can get higher rates on newly issued bonds.
Individual bond investors can create a bond ladder, which is similar to a CD ladder. Buy several bonds that invest at different maturities. For example, buy a two-year, three-year and a five-year bond. When each bond matures, reinvest the proceeds at the new, higher yield to provide an income stream and profit from rising interest rates.
If you prefer to invest in bond funds you might choose a short- to intermediate-term fund. For example, the Vanguard Short-Term Investment-Grade fund (VFSTX) has a yield of 1.92 percent, as of Sept. 11, 2017.
Stock market investments are trickier to predict during rising interest rate markets, and inflation also plays a part in the equation. In general, the stock market subsectors react distinctly to rising interest rates.
The four stock sub-groups with the best performance during rising interest rates are:
- International developed markets
- International emerging markets
- Real estate investment trusts
- Dividend-paying stocks
For long-term investors, stick with your predecided asset allocation. If you’re more adventurous, consider shifting some of your stock allocation to dividend-paying REITs or international stock funds — and away from riskier small cap stocks.
Today’s interest rates are poised to rise in the future. Prepare your finances to profit and avoid the pitfalls from higher interest rates.