What to do with your money while raising interest rates

The Federal Reserve on Wednesday announced that it would raise benchmark interest rates by three-quarters of a percentage point and indicated that more hikes would come.

The hike is the third straight move of 0.75 percentage points and the fifth hike in the past six months, all part of a central bank effort to cool uncontrolled inflation. Overall, the series of increases brought the federal funds rate to a range of 3% to 3.25%, the highest since 2008, and from a rate close to zero at the beginning of the year.

One would have to go back to 1981 to find a six-month period in which interest rates have risen the most. The numbers back then were a little more extreme: From late July 1980 to January 1981, the federal funds rate bounced from 9% to a staggering 19%, according to the Federal Reserve Bank of St. Louis.

With more interest rate hikes on the rise, it’s worth reviewing how they affect your finances and how financial experts say you can do better. adapt your savings, spending and investment strategies.

Prioritize debt payment

The Fed’s moves make it more expensive to borrow, as rates on various forms of consumer lending are pegged to the federal funds rate.

“You are facing a progressively stiffer headwind as interest rates rise,” 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.”

Further increases in interest rates will not affect a fixed rate auto loan you may have, and the same goes for fixed rate mortgages. If you carry a balance on a credit card, however, the rate you owe on that money will continue to rise along with the short-term rates set by the Fed.

With the average card currently charging an interest rate of 18.16%, according to Bankrate, it is essential to act quickly.

“The interest you save by paying off debt is the same as making an investment with the same rate of return after tax without any risk,” says Lisa Featherngill, national director of wealth planning at Comerica. “If your card has an interest rate of 22%, that’s equivalent to earning 22% on your after-tax investment.”

Credit card rates are the highest since 1996, mortgage rates are the highest since 2008, and auto loans are the highest since 2012.

Greg McBride

chief financial analyst at Bankrate

If you are unable to pay off your debt quickly, moving it to a credit card for balance transfer can ensure that you don’t have to pay interest on your outstanding balance for between 6 and 21 months.

Other options for alleviating the burden of high interest rate debt include debt consolidation with a low rate personal loan or signing up for a credit counseling service.

“If you have more than $ 5,000 in debt, it can be really profitable,” Bankrate’s senior industry analyst Ted Rossman told CNBC Make It.

Increase the interest rate you get with cash in the bank

A positive side of a rising interest rate environment is that it becomes more profitable to save. Well, depending on where you are saving.

Although deposit interest rates tend to correlate with federal funds rate hikes, you are still likely to earn next to nothing on your savings. Bank of America, Chase, US Bank, and Wells Fargo each offer an annual rate of 0.01%, according to Bankrate. Overall, the national average rate on savings accounts is only 0.13%.

There are deals to be made at online banks, however, with several offering interest rates above 2% and even 2.5% on savings accounts.

It might seem like a cold comfort to savers who are enduring inflation above 8%, said Kelly Lavigne, vice president of consumer insights at Allianz Life. “In this environment, you will lose money if you have cash on the sidelines,” she 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 on your cash reserves aren’t keeping up with inflation, earning something with your money beats next to nothing.

Choose investments wisely, think long term and “make sure you don’t panic”

If you’ve taken a look at your portfolio during the recent rate hike, you’ve probably noticed that your stocks and bonds don’t seem to be big fans of higher rates. The S&P 500 has lost around 20% so far this year as fears among investors have increased that the Fed’s efforts to slow inflation could plunge the economy into recession.

Bonds, traditionally seen as a less volatile ballast to offset equity portfolios, have not fared much better. As bond prices and interest rates move in opposite directions, bond indices were hit in 2022, with the Bloomberg Barclays US Aggregate Bond Index dropping more than 13% year-on-year.

If you’re a long-term equity investor, “you want to make sure you don’t panic,” says Lavigne. “It can be difficult to buy when the market is falling. It is best to continue to make periodic investments and not try to time the market.”

Bond investors, meanwhile, would do well to check the average duration of their portfolio, a measure of interest rate sensitivity. Longer-dated bonds typically have a longer duration, which means they will decline more in value in response to interest rate increases. Short-term bonds will tend to hold up better during rising rate regimes.

An investment that everyone would be wise to consider, at least according to Suze Orman: Series I bonds. These bonds, issued by the Treasury and known simply as “The Bonds”, pay a fixed interest rate for the life of the bond plus a rate. pegged to changes in inflation. If you buy by the end of October, you will get an interest rate of 9.62%.

There are some catches. Among them: they cannot be redeemed within 12 months of the purchase date and you will face a penalty equal to three months of interest if you collect at any time during the first five years of holding the bond. Bonds must be purchased directly from the Treasury website and you cannot invest more than $ 10,000 per person per calendar year.

Since there are complicated investments, it would be smart to consult with a financial planner before buying, LaVigne says. “Nobody should engage in any type of investment without first talking to a financial professional.”

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