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The Federal Reserve raised its benchmark interest rate on Wednesday for the sixth time in a row to a range of 3.75% to 4%.
While there may be plenty of downside in the form of higher consumer borrowing costs, one positive outcome is that your savings may start earning a little money after years of barely-there interest.
“Interest rates have increased at the fastest pace in 40 years,” said Greg McBride, chief financial analyst at Bankrate.com. “Mortgage rates have rocketed to 20-year highs, home equity lines of credit are the highest in 14 years, and car loan rates are at 11-year highs. If they’re willing to shop around, savers are seeing the best yields since 2008.”
Here are a few ways to situate your money to benefit from rising rates and protect yourself from their costs.
Bank savings: Shop around
If you’ve been stashing cash at big banks that have been paying next to nothing in interest for savings accounts and certificates of deposit, don’t expect that to change much, McBride said.
The Fed makes history with a fourth straight three-quarter-point rate hike (02NOV2022)
Thanks to the big players’ nominal rates, the national average savings rate is still just 0.16%, up from 0.06% in January, according to Bankrate.com’s October 26 weekly survey of large institutions.
But all those Fed rates hikes are starting to have a more significant impact at online banks and credit unions, McBride said. They’re offering far higher rates – with some topping 3% – and have been increasing them as benchmark rates increase.
As for certificates of deposit, there’s been a noticeable increase in return. The average rate on a one-year credit union CD is 1.05% as of October 27, up from 0.14% at the start of the year. But top-yielding one-year CDs now offer as much as 4%.
So shop around. If you switch to an online bank or credit union, however, be sure only to choose those federally insured.
Another high-yield savings option
Given today’s high inflation rates, Series I savings bonds may be attractive because they’re designed to preserve the buying power of your money. They’re currently paying 6.89%.
But that rate will only be in effect for six months and only if you buy an I Bond by the end of April 2023, after which the rate is scheduled to adjust. If inflation falls, the speed of the I Bond will fail too.
Don’t worry. You can still get a great return on these inflation-protected bonds
There are some limitations. You can only invest $10,000 a year. You can’t redeem it in the first year. And if you cash out between years two and five, you will forfeit the previous three months of interest.
“In other words, I Bonds are not a replacement for your savings account,” McBride said.
Nevertheless, they preserve the buying power of your $10,000 if you don’t need to touch it for at least five years, and that’s not anything. They also may be of particular benefit to people planning to retire in the next 5 to 10 years since they will serve as a safe annual investment they can tap into if needed in their first few years of retirement.
Suppose 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. Unlike Series I Bonds, TIPS are marketable Treasurys – meaning they can be sold before term. They pay a fixed interest every six months based on your adjusted principal. And that rate is set at the auction but never falls below 0.125%. At the most recent auction in October, for instance, the 5-year TIPS had an interest rate of 1.625%.
Credit cards: Minimize the bite
When the overnight bank lending rate – or the fed funds rate – goes up, various lending rates banks offer their customers tend to follow.
So you can expect a hike in your credit card rates within a few statements.
The average credit card rate is 18.77% as of November 2, up from 16.3% at the start of the year, according to Bankrate.com.
“This latest interest rate hike will most acutely impact those consumers who do not pay off their credit card balances in full through higher minimum monthly payments,” said Michele Raneri, vice president of US research and consulting at TransUnion.
Best advice: If you’re carrying balances on your credit cards – which typically have high variable interest rates – consider transferring them to a zero-rate balance transfer card that locks in a zero rate for between 12 and 21 months.
“That insulates you from [future] rate hikes, and it gives you a clear runway to pay off your debt once and for all,” McBride said. “Less debt and more savings will enable you to weather rising interest rates better, and is especially valuable if the economy sours.”
Just be sure to find out what, if any, fees you must pay (e.g., a balance transfer fee or annual fee) and the penalties if you make a late payment or miss a payment during the zero-rate period. The best strategy is always to pay off as much of your existing balance as possible – on time every month – before the zero-rate period ends. Otherwise, any remaining balance will be subject to a new interest rate that could be higher than you had before if rates continue to rise.
If you don’t transfer to a zero-rate balance card, another option might be to get a relatively low fixed-rate personal loan. Currently, rates on such loans range from 3% to 36%, with the average at 11.27%, according to Bankrate.com. But the best rate depends on your income, credit score, and debt-to-income ratio. Bankrate’s advice: To get the best deal, ask a few lenders for quotes before filling out a loan application.
Home loans: Lock in fixed rates now
Mortgage rates have risen over the past year, jumping more than three percentage points.
According to Freddie Mac, the 30-year fixed-rate mortgage averaged 7.08% in the week ending October 27. That is more than double where it stood a year ago.
What’s more, mortgage rates may climb further.
So if you’re close to buying a home or refinancing one, lock in the lowest fixed rate available to you as soon as possible.
What will my monthly mortgage payment be?
“That said, don’t jump into a large purchase that isn’t right for you just because interest rates might go up. Rushing into the purchase of a big-ticket item like a house or car that doesn’t fit your budget is a recipe for trouble, regardless of what interest rates do in the future,”
Lacy Rogers – Texas-based financial planner
Suppose you’re already a homeowner with a variable-rate home equity line of credit and used part of it for a home improvement project. In that case, McBride recommends asking your lender if it’s possible to fix the rate on your outstanding balance, effectively creating a fixed-rate home equity loan.
If that’s not possible, consider paying off that balance by taking out a HELOC with another lender at a lower promotional rate, McBride suggested.
Stocks: Seek broad exposure and pricing power
Regarding investing, two significant factors to consider are the effects of inflation on companies and consumers and the geopolitical outlook.
In terms of inflation, Ma noted, the costs of services – which make up a big part of the Consumer Price Index – is the thing to watch. “The big question now is how sticky the services side of inflation proves to be. While wage pressure has likely peaked, the job market still looks quite strong, and that could keep wage growth elevated and filter through to service inflation for some time to come,” Ma said.
As for geopolitics, he added, “The market seems to have put geopolitical concerns in Europe on the back-burner, but as winter looms, there is a risk that the energy warfare could escalate again.”
Financial service companies can do well in a rising rate environment because, among other things, they can make more money on loans. But a bank’s overall loan volume could decrease if there’s an economic slowdown.
In real estate, Ma said, “the sharply higher interest and mortgage rates are challenging…and that headwind could persist for a few more quarters or even longer.”
How does inflation affect my standard of living?
Meanwhile, he added, “Commodities have come down in price but still are a good hedge given the uncertainty in energy markets.”
He remains bullish on value stocks, especially small-cap ones, which have outperformed this year. “We expect that outperformance to persist going forward on a multi-year basis,” he said.
But broadly speaking, Ma suggests ensuring your overall portfolio is diversified across equities. The idea is to hedge your bets since some areas will come out ahead, but not all of them will.
If you’re planning to invest in a specific stock, consider the company’s pricing power and how consistent the demand will likely be for its product. For example, technology companies typically don’t benefit from rising rates. But since cloud and software service providers issue subscription pricing to clients, those may increase with inflation, said certified financial planner Doug Flynn, co-founder of Flynn Zito Capital Management.
Bonds: Go short
To the extent you already own bonds, the prices on your bonds will fall in a rising rate environment. But if you’re in the market to buy bonds, you can benefit from that trend, especially if you purchase short-term bonds, meaning one to three years. That’s because their prices have fallen more relative to long-term bonds, and their yields have risen more. Ordinarily, short- and long-term bonds move in tandem.
“There’s a pretty good opportunity in short-term bonds, which are severely dislocated,” Flynn said. “A similar opportunity exists in tax-free municipal bonds for those in higher income tax brackets.”
Muni prices have dropped significantly, yields have risen, and many states are in better financial shape than they were pre-pandemic, Flynn noted.
Flynn said other assets that may do well are so-called floating rate instruments from companies that need to raise cash. The floating rate is tied to a short-term benchmark rate, such as the fed funds rate, so it will go up whenever the Fed hikes rates.
But if you’re not a bond expert, you’d better invest in a fund that makes the most of a rising rate environment through floating rate instruments and other bond income strategies. Flynn recommends looking for a strategic or flexible income mutual fund or ETF, which will hold various types of bonds.
“I don’t see many of these choices in 401(k)s,” he said. But you can always ask your 401(k) provider to include the option in your employer’s plan.
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