How to take advantage of rising interest rates

Editor’s note: This is an updated version of a story that originally aired on July 27, 2022.

On Friday, Federal Reserve Chairman Jerome Powell made it clear that interest rates will likely continue to rise over the course of the current central bank attempt to crush high inflation.

The Fed intends to forcefully use its “policy-making tools to better balance supply and demand,” Powell said during his opening remarks at the Fed’s Annual Jackson Hole Economic Symposium.

The US central bank has already raised its key rate four times since March, within a range of 2.25% to 2.50%. And rates are expected to rise again when Fed governors meet next month.

This means that consumers will once again be faced with the question of where to put their savings to get the best return and how to minimize their borrowing costs.

Here are some ways to invest your money so that you can take advantage of rising rates and protect yourself from falling rates.

When the overnight bank lending rate – also known as the federal funds rate – rises, various loan rates that banks offer their customers tend to follow.

So you can expect to see your credit card rates rise within a few statements.

Currently, the average credit card rate is 17.85%, up from 16.3% at the start of the year, according to Bankrate.com.

Best Advice: 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 that locks in a zero rate for 12 to 21 months.

“It isolates you from [future] rate hikes, and that gives you a clear track to pay off your debt once and for all,” McBride said. “Less debt and more savings will make you more resilient to rising interest rates, which is especially helpful if the economy deteriorates.”

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 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 – and do it 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 the one you had before if rates continue to rise.

If you’re not transferring to a zero-rate balance card, another option might be to get a relatively low fixed-rate personal loan.

Mortgage rates have risen over the past year, jumping more than two percentage points since January.

The 30-year fixed-rate mortgage averaged 5.55% in the week ending Aug. 25, down from 5.13% the previous week, according to Freddie Mac. That’s almost double what it was this time last year (2.87%), and significantly higher than this year’s starting point (3.22%).

And mortgage rates can climb even further.

So if you’re about to buy a home or refinance one, secure the lowest fixed rate available to you as soon as possible.

That said, “don’t go into a major purchase that isn’t right for you just because interest rates might at the top. Rushing into buying a big-ticket item like a house or a car that doesn’t fit in your budget is trouble, regardless of what interest rates will do in the future,” Lacy said. Rogers, a certified financial planner based in Texas.

If you already own a home with an adjustable rate home equity line of credit and used part of it to complete a home improvement project, McBride recommends asking your lender if it’s possible to fix the rate. on your outstanding balance, creating a fixed rate home loan. Let’s say you have a $50,000 line of credit, but only used $20,000 for a renovation. You would ask that a flat rate be applied to the $20,000.

If that’s not possible, consider paying off that balance by taking out a HELOC from another lender at a lower promotional rate, McBride suggested.

If you’ve been hiding money in big banks that have paid 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.

This is because the big banks are swimming in deposits and don’t have to worry about attracting new customers.

Thanks to paltry rates from the big players, the average bank savings rate is now just 0.13%, down from 0.06% in January, according to Bankrate.com’s August 24 weekly institutions survey. The average rate on a one-year CD is 0.61%, against 0.14% at the start of the year.

But online banks and credit unions are looking to attract more deposits to fuel their booming lending businesses, McBride said. Therefore, they offer much higher rates and have increased them as benchmark rates increase.

So shop around. Today, some online accounts pay more than 2%. However, if you want to make a switch, be sure to only choose online banks and credit unions that are federally insured.

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 currently pay 9.62%.

But that rate will only be in effect for six months and only if you buy an I-Bond by the end of October, after which the rate should adjust. If inflation goes down, the I-Bond rate will also go down.

There are certain limitations. You can only invest $10,000 per year. You cannot redeem it in the first year. And if you cash out between the second and fifth year, you’ll lose the previous three months of interest.

“In other words, I-Bonds don’t replace your savings account,” McBride said.

Still, they preserve the purchasing power of your $10,000 if you don’t need to touch it for at least five years, and that’s a big deal. They can also be particularly beneficial for people planning to retire in the next 5-10 years, as they will serve as a safe annual investment that they can tap into as needed during their early retirement years.

If inflation proves persistent despite higher interest rates, you might also consider investing in 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 difficult to tell which sector, asset class or company is certain to perform well in a rising rate environment, Ma noted.

“It’s not just rising rates and inflation, there are geopolitical concerns…And we have a downturn which may or may not lead to a recession…It’s a mix unusual, even rare, of several factors,” he said.

So, for example, financial services companies generally do well in a rising rate environment because, among other things, they can make more money on loans. But in the event of a downturn, a bank’s overall lending volume could decline.

That’s why Ma suggests making sure your overall portfolio is broadly diversified among stocks, with some exposure to commodities, real estate, and maybe even a small amount of precious metals.

“Consider being diversified in areas that historically have done well in rising and inflationary rate environments,” he said.

The idea is to hedge your bets, as some of these areas will win, but not all.

That said, if you are considering investing in a specific stock, consider the firm’s pricing power and the consistency of likely demand for its product. For example, technology companies generally do not benefit from rising rates. But because cloud service and software providers publish subscription prices for customers, those can go up with inflation, said certified financial planner Doug Flynn, co-founder of Flynn Zito Capital Management.

To the extent that you already own bonds, your bond prices will fall in a rising rate environment. But if you’re in the market to buy bonds, you You can take advantage of this trend, especially if you buy short-term bonds, i.e. one to three years, since prices have fallen more than usual compared to long-term bonds. Normally, they move lower in tandem.

“There is a pretty good opportunity in short-term bonds, which are badly dislocated,” Flynn said. “For those in higher tax brackets, a similar opportunity exists in tax-free municipal bonds.”

Ammunition prices have fallen significantly, yields have increased, and many states are in better financial shape than they were before the pandemic, he noted.

Other assets that are likely to do well are so-called floating rate instruments from companies that need to raise cash, Flynn said. The floating rate is tied to a short-term benchmark rate, such as the federal funds rate, so it will rise each time the Fed raises rates.

But if you’re not a bond expert, you’re better off investing in a fund that specializes in exploiting a rising rate environment through floating rate instruments and other strategies. bond income. 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 those 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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