Now that the Federal Reserve has announced its intention to begin raising interest rates, many retirees want to know: What do higher interest rates mean for their savings?
To give you a brief primer, the Fed controls the federal funds rate, which is the rate at which banks and other “depository institutions” lend each other money. All other commercial and consumer lending rates are tied to the federal funds rate; when financial institutions pay more to borrow money, they pass the higher cost to customers. To help increase the availability of money to lend and boost the economy, the Fed has kept the target federal funds rate close to 0.0% since 2008. Now that the economy is on firmer footing, the Fed wants to begin raising rates to “normal” levels.
Thomas:
Interest rates can affect your financial picture in several ways. On the positive side, when the Fed starts raising rates, banks and other financial institutions will likely start raising the rates they pay on savings accounts, Certificates of Deposit, and other savings instruments to attract customers. Bond issuers will also likely raise the interest rates they pay on new bonds, offering fixed income investors higher payments in order to compete.**
Robert:
However, since bond prices and interest rates move in opposite directions, the market value of current bond holdings will fall when rates go up. This is because bonds with lower interest payments become less desirable when higher interest bonds are available. Price changes only affects investors who want to sell their bonds on the market though retirees may see their account balance fluctuate. Interest rate changes don’t affect the payments on existing bonds or other fixed income investments because the interest rate is set at issuance. Investors who hold their bonds until maturity still receive the full face value back regardless of the market price.
Thomas:
Higher interest rates will also translate into higher rates on credit card, auto, and home loans, making it more expensive to borrow money. If you carry a high balance on your credit cards or other variable rate debt you may see your monthly payments go up as rates rise. Heavy debt loads can make it very difficult to make progress toward your financial goals, so we strongly recommend paying down debt as soon as possible.
Robert:
Interest rates also indirectly influence the stock market; though the relationship is complicated, retirees can expect volatility around the timing of interest rate changes as investors adjust to new financial realities. Keep in mind that rates on consumer loans and investments don’t move in lockstep with the federal funds rate. A complex cocktail of factors like market forces, credit history, investor confidence, and inflation expectations can all influence where rates in different areas of the market go.
Conclusions:
Interest rates are just one factor influencing your finances. While retirees can look forward to higher bond payments and better returns on their cash savings, they need to look out for higher consumer loan rates. If you’re worried about how interest rates will affect your bond holdings or your ability to qualify for loans, we recommend speaking to a financial professional who can take a look at your financial situation and give you personalized advice.
Still have questions about retirement? Check out our free retirement resources at: http://www.frossandfross.com/resource-center/retirement.
*Securities and advisory services offered through SII Investments, Inc., member FINRA, SIPC and a Registered Investment Advisor. Fross and Fross Wealth Management and SII Investments, Inc. are separate companies. SII does not provide tax or legal advice.
** Fixed income investments are subject to various risks including changes in interest rates, credit quality, inflation risk, market valuations, prepayments, corporate events, tax ramifications and other factors.
