Interest rates affect everything from how much your savings earn to how much you pay to borrow money. So it’s no surprise that when interest rates rise — or fall — your approach to money management might change.
Here’s how rising rates may affect your priorities.
The Federal Reserve (the Fed) monitors inflation and the employment rate. During the Great Recession in 2008, the central bank lowered rates to zero in an attempt to restore the economy. Starting in 2015, the Fed began to slowly raise rates to reflect a strengthening economy.
“I would call the rising rates more of a shift to normalization,” says John Falk, vice president at U.S. Bancorp Investments. Some experts think the Fed’s current strategy of raising rates slowly and based on economic strength, could mean the effect of rising rates on today’s market is more complex.
Generally, investors shift more money to fixed income investments – like bonds – as interest rates increase. Since investors often put more money into stocks during a bull market, there may be a more pronounced shift back towards fixed income investments as rates rise and become more attractive.
A shift to bonds can be a smart choice for investors who are nearing retirement and are more interested in capital preservation than big returns. Younger investors, on the other hand, might choose to not make adjustments because their investing timeline is long enough to weather a downturn.
“Maybe some of the market risk you took in the last couple years you don’t need to take anymore,” Falk says. “Bonds, and things that are safer, are becoming a little bit more attractive.” However, your investment plan should be tailored specifically to your personal situation. “Don’t look at the market, rather determine if you are “on track financially to hit your goals,’” Falk says.
A financial professional can help navigate these decisions with different models and outcomes to project how your investments might weather different circumstances and can help you decide whether to reallocate or keep your portfolio as is.
As interest rates increase, so does the market rate for consumer debt. Re-assess your debt with these considerations in mind:
Falk suggests the same strategy for saving money that he does for debt: Stick to your game plan.
Generally, people save for goals, such as an emergency fund or a home, and not for the interest their savings account will return. Still, there are smart ways to potentially capitalize on rising rates without changing your priorities.
Because the Fed monitors inflation and employment, its decisions can be reactive. If the U.S. economy were to show signs of weakness, such as a jump in unemployment, interest rates may not continue to increase as expected. Although, Falk says, “It may not happen at the pace that it has for the past three or four years, but I think interest rates will normalize. We’re still at historically low interest rates.”
The uncertainty of rate changes is one reason Falk and other experts recommend using your personal goals to help determine how you manage your savings, debt and investments.
Rates can play a factor in the choices you make — such as how quickly you pay down debt or your asset allocations — but your personal circumstances and goals are a bigger priority than the central bank’s next move.
Managing your finances can be a balancing act, but it is possible. Read How to balance money.