The Federal funds rate is on the rise from 1.5% to 1.75% (and is predicted to continue going up through year-end). Rising interest rates can mean good and not-so-good things for the average consumer.
On the one hand, rising interest rates mean it’s a great time to be a saver! On the flip side, if you have any consumer debt or are planning on assuming any, it’s going to cost you that much more to borrow. And from what we know about consumer debt in the United States, people have a lot of it. According to the latest numbers from the Federal Reserve, household debt in America has reached $13.15 trillion with $834 billion of that total being credit card debt.
Here’s what you need to know about rising interest rates and how you can use them to your financial advantage.
Understanding Interest Rates
First, let’s take a closer look at what causes interest rates to rise and fall in the first place.
When we were in a recession, the Federal Reserve lowered its primary interest rate, which is called the Fed Funds rate, in an effort to stimulate the economy. The purpose of lowering rates is to accomplish the Federal Reserve’s primary goal of managing inflation in order to keep the prices of things Americans buy stable.
Lowering the Fed’s rate doesn’t directly lower consumer rates on things like credit card interest rates and mortgages because the government doesn’t actually control those rates, but typically most interest rates follow suit. Lower interest rates make borrowing money more affordable for consumers, who tend to rein in spending during tough economic times. However, now that the economy has rebounded, interest rates are on the rise. The Federal Reserve has been slowly raising its primary interest rate, and some market signals indicate that they’ll raise it again in December, but that’s never a sure thing. No one can predict the future so we’ll see what actually happens.
Without getting into an overly technical discussion about interest rates, the bottom line is that when interest rates are low, borrowing money is cheap and people tend to spend more. However, many worry that chronically low interest rates can lead to inflation. When interest rates rise, people borrow less money, and the goal is to slow growth of things like prices and wages. It’s a balancing act.
How to Take Advantage of Rising Interest Rates
Rising interest rates aren’t all bad. In fact, rising interest rates make it an ideal time to save and watch the power compounding interest has on your portfolio!
Shop Around for a High-Yield Saving Account
According to Bankrate, high-yield savings accounts are offering annual APY (annual percentage yield) as high as 2.26% with little to no annual fees. Now is the time to make sure you aren’t leaving your emergency cash reserves in a low-interest account. Just make sure that whichever institution you use is FDIC insured and that your balances don’t exceed $250,000 in any account or institution.
Most of the brick-and-mortar banks offer high-yield online savings accounts. So shop around for the best rates and terms, and take advantage of the rising rates.
Maximize Your Purchasing Power
With increasing interest rates comes a strengthened dollar. Therefore, now might be the time to book that international vacation! Take advantage of your greater purchasing power and use those airline points you’ve been stocking up on.
Remain Focused On Your Long-Term Investment Strategy
Don’t get caught up in daily market fluctuations and noise from media pundits. Turn it off. History tells us that stock prices are unpredictable in the short-term. The market doesn’t respond the way theorists speculate. The market will fluctuate.
Instead of having emotions about the market, what you need is an investment philosophy that will stand the test of time. If you have that, stay the course with your well-diversified portfolio that accounts for your risk tolerance, risk capacity, goals, and time horizon with a mix of globally diversified assets. Interest rate changes should not demand a change in your long-term investment strategy. If anything, a well-planned, long-term investment strategy already accounts for variables just like these!
Interest rates can be friend or foe. The biggest thing you will want to avoid with rising interest rates is assuming too much consumer debt. So, if you have credit card debt or other high-interest debt, try to get it paid off in full as quickly as possible. And if you aren’t in debt, try to stay that way. A booming economy can make it easy to get swept up in purchases that exceed your income. Enjoy your spending power, but don’t get carried away by it.