How Rising Interest Rates Affect Your Finances

No matter where you are in your life, rising interest rates will have an impact on your finances. Whether you are at the beginning of your financial journey, are mid-life, nearing retirement or retired, the changing interest rate environment will affect you.

If you pay attention to the financial news, you will have noticed that the Federal Reserve has been gradually raising interest rates since December 2015. A change in interest rates is the result of many economic factors and often is unpredictable. Nevertheless, a changing rate environment can also be an opportunity to reassess your financial plan. If you do not have a financial plan, this is a good time to create one. A financial plan will help you to keep the focus where it should be—on your long-term goals. Reviewing your financial plan will also ensure that your investments are properly diversified so the impact of an increase in interest rates is well thought out in advance and does not prompt a reactionary response. Therefore, as rates rise, it is worth re-assessing your interest rate exposure.

Let’s examine the downside and upside of rising interest rates. First, we’ll look at the downside of rising rates.

• Any existing variable rate borrowing such as credit cards, home equity lines of credit, student loans and variable rate mortgage loans will be more expensive because your payments will increase as interest rates rise.
• Any new variable rate loans will also be more expensive.
• Your current fixed rate holdings such as bond funds (Mutual Funds and Exchange Traded Funds) will lose value as rates increase. This is because when rates go up, bond prices fall with duration of the bond impacting the magnitude of the decline. (Duration affects a bond’s sensitivity to changes in interest rates, therefore the effect of rising interest rates will impact a ten-year bond differently than a five-year bond.) It is worth noting that individual bonds held to maturity will not be affected; you will get the principal back at maturity. However, if you trade the bond prior to maturity, you could end up receiving less than the bond’s face value.

There are also upsides to rising rates.

• Any existing fixed rate borrowing such as fixed rate mortgages will not be affected.
• Interest rates for deposit accounts, money market accounts and new CDs will gradually increase, so you will earn more on your deposits.
• Interest earned from bonds can be reinvested at higher rates, but as previously mentioned, the value of the bonds will go down.
• Variable rate investments such as senior secured loans, will earn more as rates rise.

You will also need an action plan to be sure that you make the most of the rising interest rate environment. To start, review your financial plan and interest rate risk with your financial planner. Next, assess your interest rates for both deposits and debts; what you are earning on your investments as well as what you are paying for loans. Should you be shifting your funds to a higher earning deposit account? Review your debts and understand which accounts are variable and which are fixed. If you have variable rate debts or loans, should you be shifting to a lower rate account? Lastly, don’t rush to sell your fixed income holdings just because rates are rising. Fixed income investments serve as a balancing factor to equity investments and are part of a diversified portfolio, if the economy falters and rates fall, your bond portfolio could increase in value.

MMBB members receive no-cost financial planning consultations as a benefit of membership. Our CERTIFIED FINANCIAL PLANNER™ professionals are available to discuss your financial concerns. Call us at 800.986.6222 or email [email protected] today to ensure that you are on your way to a financially secure future.