What do you do with your money when interest rates are going up
The Federal Reserve announced on Wednesday that it will raise benchmark interest rates by three-quarters of a percentage point and signaled more increases ahead.
The rise is the third consecutive step of 0.75 percentage point and the fifth increase in the past six months – all part of the central bank’s effort to cool hyperinflation. Finally, the streak of rallies pushed the fed funds rate into a range of 3% to 3.25%, its highest level since 2008, and above a near-zero rate to start the year.
You’d have to go back to 1981 to find a six-month period in which interest rates rose the most. The numbers at the time were more extreme: From the end of July 1980 through January 1981, the federal funds rate rebounded from 9% to 19%, according to the St. Louis Federal Reserve.
With interest rates increasingly high, it’s worth reviewing how they affect your money and how financial experts say you can do better Adjust saving, spending and investment strategies.
Prioritize debt repayment
The Fed’s moves make borrowing more expensive, since interest rates on several forms of consumer borrowing are tied to the federal funds rate.
“You’re heading into tougher headwinds as interest rates go up,” Greg McBride, chief financial analyst at Bankrate, told CNBC. “Credit card rates are the highest since 1996, mortgage rates are the highest since 2008 and auto loans are the highest since 2012.”
Additional interest rate increases will not affect the fixed rate car loan you may get, and the same is true for fixed rate mortgages. If you carry a balance on a credit card, the rate you owe on that money will continue to rise along with the short-term rates set by the Federal Reserve.
With the average card currently charging an interest rate of 18.16%, according to Bankrate, it’s essential to take action ASAP.
“The interest you save by paying down debt is the same as investing at the same rate of return on an after-tax basis without risk,” says Lisa Fetherngel, National Director of Wealth Planning at Comerica. “If your card has a 22% interest rate, that’s the same as a 22% profit on your after-tax investment.”
If you are unable to pay off your debt quickly, converting your debt to a balance transfer credit card can ensure that you will not owe any interest on your outstanding balance for 6 to 21 months.
Other options for debt relief with higher interest rates include consolidating your debt under a low-rate personal loan or signing up for a credit counseling service.
“If you have more than $5,000 in debt, this can really be beneficial,” Ted Rossman, senior industry analyst at Bankrate, told CNBC Make It.
Increase the interest rate you get on cash in the bank
One of the silver linings to an environment of rising prices is that it becomes more profitable than saving. Well, depending on where you save up.
Although deposit interest rates tend to correlate with a higher federal funds rate, you can still potentially earn nearly nothing on your savings. Bank of America, Chase, US Bank, and Wells Fargo all offer an annual rate of 0.01%, according to Bankrate. In all, the average national average for savings accounts is just 0.13%.
However, there are deals that can be struck at online banks, many of which offer interest rates north of 2%, and even 2.5% on savings accounts.
This may seem like a cool respite for savers suffering from 8% inflation, notes Kelly Lavigne, vice president of consumer insights at Allianz Life. “In this environment, you’re going to lose money if you have cash on the margins,” he says.
However, financial professionals recommend keeping enough cash to cover at least three to six months of living expenses in an emergency fund: “That way, if the worst happens, you have enough to cover your bills,” he says. And even if the current rates of your cash reserves are not keeping pace with inflation, earning something on your money outweighs earning close to nothing.
Choose investments wisely, think long-term, and “make sure you don’t panic”
If you take a look at your portfolio amid the recent interest rate hike regime, you’ve probably noticed that your stocks and bonds don’t seem to be a big fan of the higher rates. The S&P 500 has shed about 20% so far this year as concerns mount among investors that the Federal Reserve’s efforts to slow inflation could push the economy into recession.
Bonds, traditionally seen as a less volatile weight to balance stock portfolios, haven’t fared much better. With bond prices and interest rates moving in opposite directions, bond indices were hit with a rush in 2022, with Bloomberg’s Barclays US Aggregate Bond Index shedding more than 13% over the year.
If you’re a long-term stock investor, “you want to make sure you don’t panic,” says Lavigne. “Buying can be difficult when the market is going down. It is best for you to continue to make periodic investments and not try to time the market.”
In the meantime, bond investors would be wise to check the average duration of their portfolio, which is a measure of interest rate sensitivity. Generally, bonds with longer maturities come with a longer duration, which means that they will decline more in value in response to higher interest rates. Short-term bonds tend to hold up better during higher rates.
One wise investment everyone should consider, at least according to Suze Orman: Series One Bonds. These bonds, issued by the Treasury and known simply as “I bonds,” pay a fixed interest rate for the life of the bond plus a rate linked to changes in inflation. If you buy before the end of October, you will get an interest rate of 9.62%.
There are a few catches. Among them: It can’t be redeemed within 12 months of the purchase date, and you’ll face a penalty equal to three months’ interest if you withdraw the bond at any time within the first five years of owning the bond. Bonds must be purchased directly from the Treasury’s website, and you cannot invest more than $10,000 per person in a calendar year.
Since there are complex investments, it would be smart to consult a financial planner before making a purchase, says Lavigne. “No one should be involved in any one type of investment without speaking with a financial professional first.”
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