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Do rising interest rates mean you should reprioritize your financial approach?

When interest rates are slowly but steadily increasing, you may want to think through how you balance saving, debt and investing.

Tags: Debt, Interest rate, Investing, Savings
Published: March 13, 2019

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.
 

Why do interest rates change?

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.

 

Managing investments based on rate changes

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.

 

Prioritizing your debt

As interest rates increase, so does the market rate for consumer debt. Re-assess your debt with these considerations in mind:

  • Fixed-rate loans: While fixed-rate loans won’t change, adjustable-rate loans will likely get more expensive. To combat this, Falk encourages using fixed-rate products when rates are on the rise to lock a lower rate in. For example, if you have a home equity line of credit (HELOC), check to see if your interest rate is variable, as HELOC rates frequently are. “Some of these go up every time the interest rate rises,” Falk says.
  • Credit card interest: Most credit card interest is adjustable, meaning it’s determined by market rates. If interest rates increase, your credit card interest payments probably will, too. High-interest debt should be a bigger priority because it will begin to cost you more.
  • Savings: “If you have savings you could use to pay down some types of debt, I would suggest evaluating your options,” Falk says. Any money you have in a savings account is likely earning less than 2 percent in interest, he points out. The returns you’d get from keeping the money in your savings accounts is almost certainly less than the money you’d save by eliminating your debt and avoiding higher interest payments.
  • Home loans: If you’ve decided you want to be a homeowner, Falk explains, that’s a goal you’re likely to pursue regardless of rates. Stick to your plan: If you want to buy in five years, don’t rush the process because of the Fed.
     

Shifting saving strategies

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.

  • Change your savings account type. If you’re using a regular savings account, consider a money market savings account, which may offer higher rates than it did a few years ago. These accounts may require minimum balances or have other restrictions but tend to pay more in interest than a basic savings account.
  • Create, or add to, an emergency fund when your financial circumstances are good. This can be a safety net if the economy slows or your situation changes. “Your biggest asset in your working years is your ability to earn income,” says Falk. “If by chance that changes, you don’t want to liquidate a portfolio to meet your monthly living expenses.”
     

Nothing is certain

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.