Peaking Your Interest—How Rising Interest Rates will Impact Your Finances
Smart borrowers watch the Federal Reserve’s actions and statements for clues about the general direction of interest rates. In December 2015, the Fed raised its benchmark federal funds from near zero to a range of 0.25% to 0.5%, signaling that rates might be on the rise in 2016.
The Federal Funds rate is used to determine a variety of other short-term rates that touch us all in our daily finances, such as interest on bank deposits, loans, credit cards and adjustable rate mortgages. While the Fed influences short-term rates, longer-term rates, like the 10-Year Treasury, are influenced by other factors such as inflation and growth expectations.
According to Forbes.com, short term interest rates are expected to head up, but at a fairly mild pace. They believe the Federal Reserve will start pushing short-term rates up this summer. Long-term rates are also expected to rise, thanks to global demand.
So how does this affect you? Should you start searching for better rates on your personal checking and saving accounts now? Andy Saeger, VP and senior financial consultant for Charles Schwab in Naperville recommends using a bond ladder. “For investors managing their own bond portfolios, a bond ladder can be a good way to manage a bond portfolio through the ups and downs of an interest rate cycle,” said Saeger. “A bond ladder provides investors a disciplined way to build a bond portfolio. It is a strategy that has the flexibility to serve investors’ needs in all interest rate environments.”
Essentially, when rates go lower, owning some longer bonds can help keep investors’ cash flow from falling too much. “If rates stay the same over time, the yield of the portfolio will move towards the yield of the longest bonds in the portfolio. If rates go higher, investors can reinvest shorter term bonds that mature at higher yields and generate more cash flow in the future,” said Saeger.
Review Your Plan
Any interest rate rise will most likely be gradual. So experts suggest you don’t over react but rather review your financial plan.
“If you stay on top of your own financial situation, stay diversified and true to your goals, and carefully consider your borrowing needs, you should be able to lessen any negative impact of a rise in interest rates and perhaps turn it to your advantage,” said Saeger.
Better Return on Savings
The good news about rising interest rates is that investors will receive a better return on money held in savings accounts. Short-term CD rates should also go up, but not all CD rates will rise by the same amount. Saeger says investors should consider their individual circumstances and make decisions about how and where to save and invest based on a financial plan.
“Investors shouldn’t be chasing yield and returns, and taking on more risk than may be appropriate for them. Investors may also want to be watchful of longer-term bonds and bonds with low credit quality,” said Saeger.