Editor’s note: This is an updated version of a story that originally ran on August 26, 2022.
In its ongoing bid to stop high inflation, the Federal Reserve on Wednesday raised the overnight rate of bank loans 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 hike, which will put pressure on other interest rates throughout the economy.
For consumers, the Fed’s move will once again fuel 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 to come, it will put further pressure on the budgets of variable-rate households. debts like household lines of credit and credit cards,” said Greg McBride, chief financial analyst at Bankrate.com. “On a positive note, savers are seeing high-yield savings accounts and certificates of deposit at levels last seen in 2009.”
Here are a few ways to position your money so you can take advantage of rising rates, and protect yourself from their downside.
When the overnight bank lending rate – also known as the fed funds rate – rises, various lending rates that banks offer their customers tend to follow suit.
So you can expect to see a hike in your credit card rates within a few statements.
Currently, the average credit card rate is 18.16%, up from 16.3% at the start of the year, according to Bankrate.com.
Best advice: If you’re carrying balances on your credit cards — which typically have high variable interest rates — try switching them to a zero-rate balance transfer card that locks in a zero rate for between 12 and 21 months.
“That isolates 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 better weather rising interest rates, and is especially valuable if the economy sinks.”
Just be sure to find out what, if any, fees you have to pay (eg 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 rate period ends Otherwise, any remaining balance will be subject to a new interest rate which may be higher than you had before if rates continue to rise.
If youare not transferring to a zero rate balance card, another option may be to get a relatively low fixed rate personal loan.
Mortgage rates have increased over the past year, jumping more than three percentage points.
The 30-year fixed-rate mortgage averaged 6.29% in the week ending Sept. 22, up from 6.02% the week before, according to Freddie Mac. That is more than double what it was mid-September last year (2.86%), and notably higher than where it started this year (3.22%).
And mortgage rates can climb even further.
So if you’re close to buying a home or refinancing, lock in the lowest fixed rate available to you as soon as possible.
That said, “don’t jump into a big purchase that isn’t right for you just because the interest rate might go up on Rushing into the purchase of a big-ticket item like a house or car that doesn’t fit into your budget is a recipe for trouble, regardless of what interest rates do in the future,” said Texas-based certified financial planner Lacy Rogers.
If you’re already a homeowner with a variable rate home equity line of credit, and you’ve used part of it to do a home improvement project, McBride recommends asking your lender if it’s possible to lower the rate on your outstanding balance to fix, and effectively create a fixed rate home equity loan. Say you have a $50,000 line of credit but only used $20,000 for a renovation. You would ask to have a flat rate applied to the $20,000.
If that’s not possible, consider paying off the balance by taking out a HELOC with another lender at a lower promotional rate, McBride suggested.
If you have not stashed away money at big banks paying next to nothing in interest for savings accounts and certificates of deposit, don´t expect that to change just because the Fed raises rates, McBride said.
That’s because the big banks are swimming in deposits and don’t have to worry about attracting new customers.
Thanks to the big players’ meager rates, the average bank savings rate is now just 0.13%, up from 0.06% in January, according to Bankrate.com’s Sept. 14 weekly survey of institutions. The average rate on a one-year CD is now 0.77% as of September 19, up from 0.14% at the beginning of the year.
But online banks and credit unions are looking to attract more deposits to feed their booming lending businesses, McBride said. As a result, they offer much higher rates and have raised them when benchmark rates go higher.
So shop around. Today, some online savings accounts pay more than 2%. And top-yielding one-year CDs offer as much as 2.50%. However, if you want to make a switch, 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 in effect for six months and only if you buy an I-Bond at the end of October, after which the rate is scheduled to adjust. If inflation falls, the rate on the I-Bond will also fall.
There are some limitations. You can only invest $10,000 per year. You cannot redeem it in the first year. And if you exchange between two and five years, you lose the previous three months of interest.
“In other words, I-Bonds are not a substitute for your savings account,” McBride said.
However, they retain the purchasing power of your $10,000 if you don’t have to touch it for at least five years, and that’s not nothing. They can also be of particular benefit to people who plan to retire in the next 5 to 10 years, as they will serve as a safe annual investment that they can tap into when needed in their first few years of retirement.
If inflation is showing 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 the markets today makes it difficult to say which sector, asset class or company is sure to do well in a rising rate environment, Ma noted.
“It’s not just rising rates and inflation, there are geopolitical concerns … And we have a slowdown that could lead to a recession or maybe it won’t … It’s an unusual, even rare, mix of multiple factors,” he said.
Thus, financial services companies can do well in a rising rate environment, because among other things they can earn more money on loans. But if there is an economic slowdown, a bank’s total loan volume may go down.
In terms of real estate, Ma said, “the sharply higher interest and mortgage rates are challenging … and those headwinds could continue for a few quarters or even 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 ones, which have performed this year. “We expect that outperformance to continue on a multi-year basis,” he said.
But in general, Ma suggests making sure your total portfolio is spread across stocks. The idea is to hedge your bets, since some of those areas will come out ahead, but not all.
That said, if you plan to invest in a specific stock, consider the company’s pricing power and how consistent the demand for its product is likely to be. For example, technology companies typically do not benefit from rising rates. But since cloud and software service providers issue subscription prices to clients, they may rise with inflation, said certified financial planner Doug Flynn, co-founder of Flynn Zito Capital Management.
To the extent that you already own bonds, the prices on your bonds will fall in a rising rate environment. But if you are in the market to buy bonds you can benefit from that trend, especially if you buy short-term bonds, which means one to three years. That’s because their prices have fallen more relative to long-term bonds, and their yields have risen more. Normally, short-term and long-term bonds move in tandem.
“There is a great opportunity in it short-term bonds, which are seriously underperforming,” Flynn said. “For those in higher income tax brackets, a similar opportunity exists in tax-free municipal bonds.”
Ma added that 2-year Treasuries, which yield nearly 4%, “are appealing here because we don’t expect the Fed to go much above that level with short-term interest rates.”
Muni rates have dropped significantly, yields have risen, and many states are in better financial shape than they were pre-pandemic, Flynn noted.
Other assets that could do well are so-called floating rate instruments of companies that need to raise cash, Flynn said. The floating rate is tied to a short-term benchmark rate, such as the fed funds rate, so it will go up when the Fed raises rates.
But if you’re not a bond expert, you’re better off investing in a fund that specializes in making the most of a rising rate environment through floating rate instruments and other bond income strategies. Flynn recommends looking for a strategic income or flexible income mutual fund or ETF, which will hold an array of different types of bonds.
“I don’t see a lot 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.