In its continued efforts to combat high inflation, the The Federal Reserve on Wednesday raised the overnight bank lending rate to a range of 3% to 3.25%.
It was the U.S. central bank’s fifth increase in six months and its third straight increase of 75 basis points, putting upward pressure on other interest rates across the economy.
For consumers, the Fed’s decision will raise the question of where to invest their savings to get the best return and how to lower their borrowing costs.
“Credit card rates hit their highest level since 1995, mortgage rates hit their highest level since 2008, and auto loan rates hit their highest since 2012.”
With further rate hikes underway, households with variable rate debt, such as home equity lines of credit and credit cards, will be further strained,” said Greg McBride, chief financial analyst at Bankrate.com.
“On the positive side, high-yield savings accounts and certificates of deposit are at levels last seen in 2009.”
Here are some strategies for positioning your money to take advantage of rising rates while protecting you from their inconveniences.
Credit cards: reduce the sting
When the overnight bank lending rate, also known as the federal funds rate, rises, the same goes for the different loan rates that banks offer their customers.
As a result, expect your credit card rates to increase within a few statements.
According to Bankrate.com, the average credit card rate is currently 18.16%, down from 16.3% at the start of the year.
If you have balances on your credit cards, which typically have high variable interest rates, consider transferring them to a zero-rate balance transfer card, which locks in a zero rate for 12 to 21 months.
“It protects you from future rate hikes and gives you a clear track to pay off your debt once and for all,” McBride explained. “Less debt and more savings will help you weather rising interest rates, which is especially important if the economy is deteriorating.”
Just make sure you know what fees, if any, you’ll have to pay (for example, a balance transfer fee or an annual fee) and what the penalties will be if you make a late or missed payment during the rate period. zero. .
The best strategy is to pay off as much of your existing balance as possible before the end of the zero rate period and to do so on time each month. Otherwise, any remaining balance will be subject to a new interest rate, which may be higher than the one you had before if interest rates continue to rise.
Lock in fixed rates on home loans now.
Mortgage rates have risen more than three percentage points over the past year.
According to Freddie Mac, the 30-year fixed rate mortgage averaged 6.29% in the week ending September 22, compared to 6.02% the previous week. That’s more than double what it was in mid-September last year (2.86%), and significantly higher than where it started this year (3.22%).
Mortgage rates could rise further.
So if you’re considering buying or refinancing a home, secure the lowest fixed rate available as soon as possible.
If you don’t want to transfer to a zero interest balance transfer card, another option is to get a low interest fixed rate personal loan.
That being said, “don’t rush into a big purchase that isn’t right for you just because interest rates may go up.” “Regardless of what interest rates do in the future, rushing into buying a big ticket item like a house or car that doesn’t fit into your budget is a headache,” he said. Lacy Rogers, Certified Financial Planner based in Texas. .
If you already have an adjustable rate home equity line of credit and used part of it for a home improvement project, McBride suggests asking your lender if you can fix the rate on your outstanding balance, creating a fixed rate mortgage.
Say you have a $50,000 line of credit, but only use $20,000 for a renovation. You would request that a flat rate be applied to the amount of $20,000.
If that’s not an option, McBride suggests paying off the balance with a HELOC from another lender at a lower promotional rate.
Save money while shopping.
If you’ve been hiding money in big banks that pay next to nothing in interest on savings accounts and certificates of deposit, McBride says don’t expect that to change just because the Fed raises rates .
According to Bankrate.com’s weekly survey of institutions conducted on September 14, the average bank savings rate is now 0.13%, down from 0.06% in January. As of September 19, the average rate on a one-year CD was 0.77%, compared to 0.14% at the start of the year.
According to McBride, online banks and credit unions are looking to attract more deposits to fuel their thriving lending businesses. As a result, they offer much higher rates and have increased them as benchmark rates have increased.
So do some comparison shopping. Some online savings accounts now pay more than 2%. Top-performing 1-year CDs can pay up to 2.50%. If you decide to make the switch, be sure to only use online banks and federally insured credit unions.
Another high yield investment option
Given today’s high inflation rates, Series I savings bonds may be attractive because they are designed to preserve the purchasing power of your money. They are currently paying 9.62% interest.
However, this rate will only be in effect for six months if you purchase an I-Bond by the end of October, after which the rate will be adjusted. If inflation goes down, the I-Bond rate will also go down.
There are some restrictions. You are only allowed to invest $10,000 per year. It is not refundable the first year. Also, if you make a withdrawal between the second and fifth year, you will lose the previous three months of interest.
“In other words, I-Bonds are not a replacement for a savings account,” McBride explained.
Nevertheless, they protect the purchasing power of your $10,000 if you don’t need to touch it for at least five years, which is not insignificant. They can also be particularly beneficial for people planning to retire in the next 5-10 years, as they will serve as a secure annual investment that they can draw on if necessary during their first years of retirement.
If inflation persists despite higher interest rates, consider investing in Treasury inflation-protected securities (TIPS), according to Yung-Yu Ma, chief investment strategist at BMO Wealth Management.
Equities: Look for broad exposure as well as pricing power.
According to Ma, the confusing mix of market factors makes it difficult to predict which sector, asset class or company will do well in a rising rate environment.
“It’s not just rising interest rates and inflation, there are also geopolitical concerns…And we have a downturn which may or may not lead to a recession…” That’s an unusual, if not rare, combination of several factors,” he said.
Financial services companies, for example, can benefit from higher interest rates because, among other things, they can earn more money on loans. However, if the economy slows, a bank’s overall lending volume may fall.
On the real estate market, Ma said “the sharp rise in interest rates and mortgage rates is a challenge…and this headwind could last for a few more quarters or even longer.”
Meanwhile, “commodity prices have fallen but remain a good hedge given the uncertainty in energy markets,” he added.
He remains bullish on value stocks, especially small caps, which have outperformed this year. “We expect this outperformance to continue over the next few years,” he said.
However, Ma recommends that your overall portfolio be well diversified across stocks. The idea is to spread your bets as some of these areas will win, but not all.
However, before investing in a specific stock, consider the company’s pricing power and the regularity of demand for its product. For example, rising interest rates generally do not benefit technology companies.
However, since cloud and software service providers charge customers on a subscription basis, these fees can increase with inflation, according to certified financial planner Doug Flynn, co-founder of Flynn Zito Capital Management. .
Bonds: Sell them short.
In a rising rate environment, the prices of your bonds will fall if you already own them. However, if you are looking to buy bonds, you can take advantage of this trend, especially if you are buying short-term bonds (one to three years), as prices have fallen more than usual compared to long-term bonds. . Normally they descend together.
“A pretty good opportunity exists in short-term bonds, which are badly dislocated,” Flynn said.
Ma went on to say that 2-year Treasuries, which are yielding almost 4%, are “attractive here because we don’t expect the Fed to go much beyond this level with interest rates. short-term interest”.
He noted that muni prices have fallen significantly, yields have increased, and many states are in better financial shape than they were before the pandemic.
Other assets likely to perform well include so-called floating rate instruments issued by companies in need of cash., according to Flynn. The floating rate is frequently compared to the federal funds rate, so it increases every time the Fed raises interest rates.
If you’re not a bond expert, you’re better off investing in a fund that specializes in capitalizing on rising interest rates using floating rate instruments and other bond income strategies. Flynn suggests looking for a strategic income or flexible income mutual fund that invests in a variety of bonds.
“I don’t see a lot of those options in 401(k)s,” he says. However, you can always ask your 401(k) provider to include the option in your employer’s plan.