Dear Carrie, I've gotten so used to low interest rates that I'm not sure what to expect when they start to rise. I have both investment and savings accounts plus a mortgage and a little bit of credit card debt. Can you explain why this is happening, and what, if anything, I should do about it? —A
Reader Dear Reader, Thanks for this question that's top of mind for so many people. And it's no wonder—borrowers and investors have been in an unusually low interest rate environment for more years than they might remember. By way of background, the Fed has indicated that they will gradually increase the federal funds rate (the rate that banks charge each other for overnight loans, which has effectively been at zero for years) over the coming months with the first hikes
occurring this past March and May. Their goal is straightforward: to control inflation, currently at a 40-year high. The theory is that by raising rates, they cool down the economy by slowing demand for goods and services, which in turn slows down price increases. This works because the fed funds rate also determines a variety of other short-term rates that impact our daily finances; for example, interest on bank deposits, loans, credit cards and adjustable-rate mortgages. And ultimately
it will also have an effect on both the bond and stock markets. I can understand why all of this can be concerning, but overall, the fact that the Fed is raising rates is a positive—not only because it reflects their confidence in the strength of the economy, but also because controlling inflation is essential for the economy's long-term health. That said, rising interest rates will have an impact on all of us, so it's important to understand what it means for your different
accounts, loans and investments. Broadly speaking, an increase in rates is good for savers and bad for borrowers. It's more of a mixed bag for investors, depending on the types of investments you hold. Let's take a look. A rise in interest rates is good news for savers, although the impact on short-term savings accounts, CDs and money market accounts will take time. Competitive pressures will eventually encourage financial
institutions to offer higher rates, so it will be increasingly important to shop around, re-examine how much you need to have in cash and always be mindful of fees and charges that can reduce your returns—regardless of how much and when rates rise. Whether you're financing a new car or carrying a balance on your credit card, it may cost you more. If you have a choice between a variable or fixed interest rate loan, it's probably better to lock in low-cost financing sooner rather than later. Mortgage rates are also on the rise, which is significant if you're applying for a new home loan or have a variable-rate mortgage. Consider that a one percent interest rate increase can increase the cost of a $300,000 mortgage by over $2,000 a year. Interestingly though, rising interest rates may also lead to a deceleration in home prices, so sellers will want to factor that into their plans. Also keep in mind that the Federal Reserve has a lot more control over short-term rates than long-term rates. And as borrowing costs go up, people tend to buy less, which can shift demand and prices lower. If you think your job or business may be impacted negatively by rising rates, take extra care to look at your balance sheet and emergency funds. Impact on bond investorsWhen interest rates rise, bond values decrease. However, the impact will vary depending on your circumstances. Here are three possible scenarios courtesy of my colleague at Schwab, Kathy Jones:
Impact on stock investors
Generally speaking, interest rate hikes depress stock prices, which can translate to more market volatility. The good news is that because of all the speculation on when and by how much rates will rise, it's largely already built into stock prices. Therefore, rate increases may not have that big of an impact. As always, it's important to be diversified and to maintain a long-term view. I firmly believe that regardless of increases in interest rates, stocks remain the best way to build long-term wealth. It's still important to spread out your investments globally in a variety of sizes and types of companies, industries and sectors because interest rate hikes will likely mean different things for different sectors of the market. And it's difficult to predict how any single company will react. Keeping a balanced perspectiveGranted, this is a lot to consider, but try not to over-react. It's easy to be swayed by the never-ending media speculation and hyperbole, but if you keep on top of your own financial situation, stay diversified and true to your goals, and use extra care when borrowing, you should be able to mitigate any negative impact of a rise in interest rates—and perhaps even turn it to your advantage. Have a personal finance question? Email us at . Carrie cannot respond to questions directly, but your topic may be considered for a future article. For Schwab account questions and general inquiries, contact Schwab. We can help you build a diverse portfolio.
Related topicsThe information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision. All expressions of opinion are subject to change without notice in reaction to shifting market conditions. Data contained herein from third-party providers is obtained from what are considered reliable sources. However, its accuracy, completeness or reliability cannot be guaranteed. Examples provided are for illustrative purposes only and not intended to be reflective of results you can expect to achieve. 0522-2W7XWhich investment would you choose if you believe interest rates will go up?Short-term and floating rate bonds are also good investments during rising rates as they reduce portfolio volatility. Hedge your bets by investing in inflation-proof investments and those with credit-based yields.
What goes up when interest rates go up?This (very) simplified example shows how the Fed reduces the amount of money in the economy when it raises rates. Besides mortgages, rising interest rates impact the stock and bond markets, credit cards, personal loans, student loans, auto loans and business loans.
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