If you’re an avid news watcher or an otherwise financially-conscious person, you might’ve already heard about the Fed’s decision to increase interest rates.
In an attempt to suppress surging inflation, the Federal Open Market Committee again decided to turn up the federal fund rate from 1.50 to 1.75. The agency is also seeing inevitable future increases from the targeted 1.75 rate.
The Federal Open Market Committee raises the federal fund rate to 1.50 as recently as May of 2022; this continuous upturn of federal interest rates marks the most aggressive interest rate increase since ’94.
This looming interest hike poses many risks for different sectors of the economy. In this post, we will discuss the factors affecting the interest rate, what it means for your retirement, and what you can do to combat surging prices.
Factors Affecting Interest
Going back to Economics 101, we’ll discuss how different economic and political factors affect the federal fund rate. Understanding this concept is critical to formulating a game plan for the future.
Supply and Demand
The first factor is the most basic one — supply and demand. When more money is supplied than demanded, prices go down. In contrast, prices go up when there’s more demand for money than what’s available. The federal fund rate is no different.
The supply of funds in an economy also affects interest rates by raising or lowering them. In contrast, an increase in the demand for credit will raise interest rates, while a reduction in credit supply will lessen them.
Inflation
Inflation has a significant impact on interest rates. The higher the inflation rate, the more interest rates are likely to rise. This occurs due to lenders demanding increased interest rates to compensate for the money’s weakening purchasing power in the future.
Government
The government plays a vital role in affecting interest rates by controlling the federal fund rate. The federal fund rate is the rate at which the Federal Reserve charges member banks for borrowing money. The federal agency can also use this rate to influence other economic interest rates.
The government influences the federal fund rate through “open market operations.” Banks are injected with more money when the government buys more securities than they can use for lending, and the interest rates decrease. When the government vends securities, funds from banks are depleted for the transaction, leaving the institution with less funds for lending and forcing a rise in interest rates.
What Does This Mean for You?
Now that we know what factors affect the ebb and flow of interest rates, it’s time we learn how these changes affect us.
The Good
Many people would jump to the conclusion that an increase in interest rate is inherently harmful. However, this isn’t always the case. In fact, there are some situations where a higher interest rate is beneficial.
Here are some examples of how a higher interest rate can benefit people.
Higher CDs
CDs, or Certificates of Deposit, are a type of savings account that offers a higher interest rate than typical savings accounts. The lump-sum opening deposit is locked for a fixed period — usually around six months to five years — and you cannot access the money during that time.
The Federal Reserve Board determines the federal funds rate, affecting CD rates. When the federal funds rate rises, so do CD rates. This means that you can earn more money on your CD savings.
The Federal Open Market Committee announces whether it will increase, decrease, or leave the federal funds rate unchanged every six to eight weeks.
Higher G Funds
The G Fund, also known as the Government Securities Investment Fund, is a type of mutual fund that’s only available to federal employees enrolled in the Thrift Savings Plan.
This fund invests in short-term government securities and is one of the safest investment options. The G Fund is also unique because it’s not subject to market volatility. This government investment option pays a variable interest rate based on nonmarketable short-term treasury obligations with maturities ranging from a few days to 52 weeks.
Although the G Fund has been known to yield a lower return than other government security funds, it’s still a safe investment option with the rising interest rates. The yield on the G Fund rises along with interest rates because the fund invests in short-term treasury securities.
Higher Savings Interest
A high-interest savings account is a type of savings account that offers a higher annual percentage yield than traditional savings accounts. This high-yield saving account usually pays 20 times more than the average conventional savings account.
The rise in interest rates will lead to a higher yield on your high-interest savings account. This is good news for savers, because it means that their money will grow at a faster rate.
To sum it up, any savings or investment account relying on interest will grow faster when interest rates are soaring.
The Bad
Along with rising investments and savings accounts, any expenses relying on interest are bound to increase or double. Here are some examples of how a higher interest rate negatively affects your daily life.
Higher Mortgage Rates
A mortgage is a loan that’s used to finance the purchase of a home. Monthly mortgage payments are typically composed of principal and interest.
The principal is the amount you borrowed, while the interest is the cost of borrowing the money. The higher the interest rate, the more you’ll have to pay in interest over the life of the loan.
In general, there are different types of mortgages:
- Fixed-rate: The interest rate remains the same for the life of the loan.
- Adjustable-rate: The interest rate alters occasionally, typically in line with government-mandated interest rates.
- Interest-only: You only pay the interest for a certain period, usually five to ten years. After that, you’ll also have to start paying off the principal.
Depending on your mortgage type, your monthly payments will be affected differently.
Rising Credit Card Rates
The average credit card interest rate is about 20.17%. However, some cards have rates as high as 25.18%.
If the Federal Reserve Board raises interest rates, credit card companies will follow suit and raise their rates. This means that you’ll have to pay more in interest on your outstanding balances.
Higher Costs of Goods
The cost of goods is also affected by the rising federal fund rates. This is because when the cost of borrowing money goes up, the prices of goods and services also go up.
The rising interest rates may also lead to inflation, which is a general increase in prices. When inflation goes up, the cost of living also goes up. This means you’ll have to pay more for your needs, such as food, shelter, and clothing.
In conclusion, rising interest rates have both positive and negative effects, depending on your financial situation. You’ll see your balance grow faster if you have money saved up in an account that accrues interest, but you’ll likely have to pay more interest payments if you have debt.
What You Can Do to Protect Your Retirement
With the rising interest rates, it’s essential to look closely at your retirement savings and make sure your money is working hard for you.
Here are some tips to help you protect your retirement:
- Take advantage of high-yield savings: If you have extra cash, consider putting it into a high-yield savings account. This way, you’ll earn more interest on your money and grow your savings faster.
- Review your investment portfolio: In rising interest rate conditions, some investments will do better than others. Take a close look at your portfolio and ensure that your assets are positioned for success.
- Consider CD investment: Certificates of Deposit (CDs) offer a fixed rate of return for a set time. This makes them a great option in a rising interest rate environment.
- Avoid rate-sensitive expenses: If possible, avoid taking on new debt or making large purchases that could be affected by rising interest rates.
- Consult with a financial expert: If you’re unsure how to protect your retirement savings in a rising interest rate environment, consult with a financial expert. They can help you develop a plan that meets your specific needs.
We Can Help You Beat the Rising Interest
“Increase” and “interest rate” sound scary when used together, but there’s more to it than most people know. With proper financial planning and strategizing, you can beat the rising interest rate and protect your bright retirement future.
Our team at My Federal Plan can help you develop a personalized retirement plan that will keep you on track to achieve your retirement goals and beat the rising interest rates.
If you want to learn more about how you can prepare for your retirement in the current financial environment, download our free guide now. If you’re ready to start planning for your retirement, you can book a free consultation with one of our financial experts by completing our form here.