How do rising interest affect me?

The Federal Reserve controls short-term interest rates through their ability to add and remove reserves from the banking system. After the financial crisis of 2008, they drove down short-term interest rates to near 0% and have only recently been raising them in 0.25% increments every 3 months.

Long-term rates tend to follow short-term rates up either trailing the rise of short-term rates when inflation expectations are lower or exceeding the rise in short-term rates when inflation expectations are higher. What does this mean for you?

If you have a savings account or are in the market for CDs …

Higher short-term rates are good for you because CD and savings account rates are dependent on short-term rates and their yields will rise as short-term rates rise.

 

If you have credit card debt …

Higher-short term rates will work against you because credit card interest rates are typically dependent on short-term rates.

 

If you have an adjustable mortgage …

On your next adjustment date, expect an increase in the interest rate that you will pay. There is a limit on the increase as most adjustable mortgages have maximums for each reset and maximum rates for the life of the loan.

 

If you own short-term bonds …

The pricing you’ll see on your statement will decrease but not significantly. As the maturity date approaches, the price of the bonds will creep up to par (100.)

 

If you own long-term bonds …

The pricing you’ll see on your statement will decrease significantly, dependent on how long the maturity date is. The longer off the maturity date, the lower the price.  This should only matter to you if you plan to sell these bonds before the maturity date. Otherwise, a long-term bond will become a short-term bond over time and act the way a short-term bond does as described above.

 

If you own stocks …

Over time, stocks tend to trade based on their discounted cash flows. One of the parameters used to calculate this is interest rates. When interest rates are lower, the calculation results in a higher valuation. Conversely, when interest rates are higher, valuations shrink.

 

Conclusion

Since the financial crisis, interest rate based investments have been a place for safety, but not yield.  As interest rates normalize to higher rates, interest rate based investments will provide an alternative to those looking for yield.

 

"Education is the key to making informed financial decisions." -- Elliot Goldberg, Independent Registered Investment Advisor (610) 999-3599
“Education is the key to making informed financial decisions.” — Elliot Goldberg

Please call me at (610) 999-3599 for a no-cost, no-obligation consultation on this and other financial topics.

Leave a Reply

Your email address will not be published. Required fields are marked *