In its continued effort to tame high inflation, the Federal Reserve on Wednesday raised its overnight lending rate to a range of 3% to 3.25%.
It is the fifth increase by the US central bank in six months and its third consecutive 75 basis point increase, which will put upward pressure on other interest rates across the economy.
For consumers, the Fed’s move will reignite the question of where to park their savings for the best return and how to minimize their borrowing costs.
“Credit card rates are the highest since 1995, mortgage rates are the highest since 2008, and auto loan rates are the highest since 2012. With more rate hikes yet to come, it will further strain household budgets with variable interest rate debt like home equity lines of credit and credit cards,” said Greg McBride, chief financial analyst at Bankrate.com. “On a positive note, savers are seeing savings accounts and high-yield certificates of deposit at levels last seen in 2009.”
Here are some ways to position your money so that you can take advantage of rising prices and protect yourself from their downside.
When the overnight bank lending rate – also known as the fed funds rate – rises, they tend to follow various lending rates that banks offer to their customers.
So you can expect to see an increase in your credit card charges within a few statements.
Currently, the average credit card interest rate is 18.16%, up from 16.3% at the start of the year, according to Bankrate.com.
Best tip: If you have balances on your credit cards – which typically have high variable interest rates – consider transferring them to a zero-interest balance transfer card that locks in zero interest for 12 to 21 months.
“That isolates you from [future] rate hikes and gives you a clear runway to pay off your debt once and for all,” McBride said. “Less debt and more savings will allow you to better deal with rising interest rates, and is especially valuable if the economy turns sour.”
Just be sure to find out what, if any, fees you’ll have to pay (eg balance transfer fee or annual fee) and what the penalties will be if you make a late payment or miss a payment during the zero-interest period. The best strategy is always to pay off as much of your existing balance as possible – and do so on time each month – before the zero interest period ends. Otherwise, any balance will be subject to a new interest rate that could be higher than what you had before if interest rates continue to rise.
If you’re not transferring to a zero balance card, another option might be to get a relatively low fixed rate personal loan.
Mortgage rates have been rising over the past year, jumping more than three percentage points.
The 30-year fixed-rate mortgage averaged 6.29 percent in the week ended Sept. 22, up from 6.02 percent the previous week, according to Freddie Mac. That’s more than double what it was in mid-September last year (2.86%), and notably higher than where it started this year (3.22%).
And mortgage rates may rise even more.
So if you’re close to buying a home or refinancing one, lock in the lowest fixed rate available as soon as possible.
That said, “don’t jump into a big market that isn’t right for you just because interest rates might go up. Rushing into a big-ticket item like a house or car that doesn’t fit in your budget is a recipe for trouble, no matter what interest rates do in the future,” said Lacy Rogers, a certified financial advisor in Texas. .
If you’re already a homeowner with an adjustable-rate home equity line of credit and used some of it to do a home improvement project, McBride recommends asking your lender if it’s possible to fix the interest rate on your outstanding balance, effectively creating a fixed-rate home equity loan. interest rate. Let’s say you have a $50,000 line of credit, but you only used $20,000 for renovations. You will request that a flat rate of $20,000 be applied.
If that’s not possible, consider paying off that balance by taking out a HELOC with another lender at a lower offer rate, McBride suggested.
If you’ve been keeping cash in big banks that pay almost nothing in interest on savings accounts and certificates of deposit, don’t expect that to change just because the Fed raises rates, McBride said.
This is because the big banks are swimming in deposits and don’t have to worry about attracting new customers.
Thanks to the paltry interest rates of the big players, the average bank savings rate is now just 0.13%, down from 0.06% in January, according to Bankrate.com’s weekly Sept. 14 institutional survey. The average rate on a one-year CD is now 0.77% as of September 19, up from 0.14% at the start of the year.
But online banks and credit unions are trying to attract more deposits to fuel their booming lending businesses, McBride said. Consequently, they offer much higher interest rates and increase them as benchmark rates rise.
So shop around. Today some online savings accounts pay over 2%. And top-yield one-year CDs offer up to 2.50%. If you want to make a switch, however, be sure to choose only those online banks and credit unions that are federally insured.
Given today’s high inflation rates, Series I savings bonds can be attractive because they are designed to preserve the purchasing power of your money. They currently pay 9.62%.
But that rate will only be valid for six months and only if you buy an I-Bond by the end of October, after which the rate is scheduled to adjust. If inflation falls, the interest rate on the I-Bond will also fall.
There are some limitations. You can only invest $10,000 a year. You cannot redeem it in the first year. And if you cash out between two and five years, you’ll lose the previous three months of interest.
“In other words, I-Bonds don’t replace your savings account,” McBride said.
However, they keep your $10,000 in purchasing power if you don’t need to touch them for at least five years, and that’s nothing. They can also be particularly beneficial for people planning to retire in the next 5 to 10 years, as they will serve as a safe annuity investment that they can tap into if needed in their early retirement years.
If inflation proves sticky despite higher interest rates, you might also consider putting some money into Treasury Inflation-Protected Securities (TIPS), said Yung-Yu Ma, chief investment strategist at BMO Wealth Management.
The confusing mix of factors at play in markets today makes it hard to say which sector, asset class or company is certain to do well in a rising interest rate environment, Ma noted.
“It’s not just rising interest rates and inflation, there are geopolitical concerns … And we have a slowdown that may or may not lead to a recession … It’s an unusual, even rare, combination of many factors,” he said.
For example, financial services companies can do well in a rising interest rate environment because, among other things, they can make more money on loans. But if there is an economic slowdown, a bank’s total loan volume could decline.
As for real estate, Ma said, “sharply higher interest rates and mortgage rates are a challenge…and this headwind could persist for a few more quarters or longer.”
Meanwhile, he added, “commodities have fallen in price but are still a good hedge given the uncertainty in energy markets.”
He remains bullish on value stocks, especially small-cap stocks, which have outperformed this year. “We expect this outperformance to continue going forward on a multi-year basis,” he said.
But in general, Ma suggests making sure your overall portfolio is diversified in stocks. The idea is to hedge your bets, as some of these areas will come out ahead, but not all.
That said, if you’re looking to invest in a particular stock, consider the company’s pricing power and how consistent demand for its product is likely to be. For example, tech companies typically don’t benefit from rising interest rates. But because cloud and software providers issue subscription prices to customers, they can rise with inflation, said certified financial planner Doug Flynn, co-founder of Flynn Zito Capital Management.
To the extent you already own bonds, your bond prices will decline in a rising interest rate environment. But if you’re in the market to buy bonds, you can take advantage of this trend, especially if you’re buying short-term bonds, meaning one to three years. This is because their prices have fallen more than long-term bonds and their yields have risen more. Usually short-term and long-term bonds move in parallel.
“There is a very good opportunity for short-dated bonds, which are severely dislocated,” Flynn said. “For those in higher income tax brackets, a similar opportunity exists in tax-free municipal bonds.”
Ma added that 2-year notes, which yield nearly 4%, “are attractive here as we don’t expect the Fed to go much above this level with short-term interest rates.”
Muni rates have dropped significantly, yields are up and many states are in better financial shape than they were before the pandemic, Flynn noted.
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