What to do with your money during rising interest rates

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

The rise is the third consecutive move of 0.75 percentage points and the fifth increase in the past six months – all part of a central bank effort to calm runaway inflation. Altogether, the series of hikes took the federal funds rate to a range of 3% to 3.25%, the highest since 2008, and from near zero to start the year.

You would have to go back to 1981 to find a six-month period when interest rates rose more. The numbers back then were a bit more extreme: From late July 1980 to January 1981, the federal funds rate jumped from 9% to 19%, according to the Federal Reserve Bank of St. Louis.

With more and more interest rate hikes, it’s worth considering how they affect your finances and how financial experts say you can best adjust your saving, spending and investing strategies.

Prioritize the repayment of your debts

The Fed’s decisions make borrowing more expensive because the rates on many forms of consumer borrowing are pegged to the federal funds rate.

“You’re heading into a stronger and stronger 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 interest rate hikes will not affect any fixed rate car loan you may have, and the same goes for fixed rate mortgages. If you have a balance on a credit card, however, the rate you owe on that money will continue to rise alongside 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 as soon as possible.

“The interest you save by paying down debt is the same as making an investment with the same rate of return on a risk-free, after-tax basis,” says Lisa Featherngill, national director of wealth planning at Comerica. “If your card has a 22% interest rate, that’s like 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’re unable to pay off your debt quickly, switching your debt to a balance transfer credit card can ensure that you don’t owe interest on your outstanding balance for 6 to 21 months.

Other options to ease the burden of your high-interest debt include consolidating your debt into a low-interest personal loan or signing up for a credit counseling service.

“If you have more than $5,000 in debt, that can be really beneficial,” Ted Rossman, senior industry analyst at Bankrate, told CNBC Make It.

Increase the interest rate you get on cash in the bank

A silver lining of a rising rate environment is that it becomes more lucrative to save. Well, depending on where you’re saving.

Although interest rates on deposits tend to correlate with increases in the federal funds rate, you’re 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. In total, the national average rate on savings accounts is only 0.13%.

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

That may seem like little comfort to savers who are dealing with inflation north of 8%, points out Kelly Lavigne, vice president of consumer insights at Allianz Life. “In this environment, you’re going to lose money if you have cash in reserve,” he says.

Still, finance 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’ll have enough to cover your bills,” he says. And even if your current cash reserve rates don’t keep up with inflation, earning something on your money is worth next to nothing.

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

If you’ve taken a look at your portfolio amid the recent rate hike regime, 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 about 20% so far this year as investors fear the Fed’s efforts to curb inflation could tip the economy into recession.

Bonds, traditionally seen as less volatile ballast to offset equity portfolios, fared little better. Because bond prices and interest rates move in opposite directions, bond indices have been beaten in 2022, with the Bloomberg Barclays US Aggregate Bond Index falling more than 13% over the year.

If you’re a long-term equity investor, “you want to make sure you’re not panicking,” says Lavigne. “It can be difficult to buy when the market is down. It’s better to keep making periodic investments and not try to time the market.”

Bond investors, meanwhile, would be wise to check the average duration of their portfolio, a measure of interest rate sensitivity. Generally, bonds with longer maturities have longer durations, which means they will lose more value in response to increases in interest rates. Shorter term bonds will tend to be more resilient to 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 “I bonds”, pay a fixed rate of interest throughout the life of the bond, plus a rate indexed to variations in inflation. If you buy before the end of October, you will benefit from an interest rate of 9.62%.

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

Because there are complicated investments, it would be a good idea to consult a financial planner before buying, says LaVigne. “No one should embark on any type of investment without first discussing it with a financial professional.”

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