For some five years now, economists have been telling us to prepare for a rate increase from the Fed. It appears that they may finally be right.
In a testimony before the House Financial Services Committee on Wednesday, Fed Chair Janet Yellen confirmed that, barring any drastic changes in the economy, the Fed would likely raise rates this year.
She said the increase would probably be gradual, but “if the [economic] expansion proves to be more vigorous than currently anticipated and inflation moves higher than expected, then the appropriate path would likely follow a higher and steeper trajectory; conversely, if conditions prove weaker, then the appropriate trajectory would be lower and less steep than currently expected.”
The initial increase likely won’t make a huge difference to your personal finances, but it signals a shift toward a rising interest rate environment. “Consumers need to bear in mind the potential cumulative impact of rate hikes over several years,” says Greg McBride, chief financial analyst at Bankrate.com.
So what does it mean for you and your money? It depends.
If you’re a saver. If you’ve got money in cash or a money market fund, you’re likely used to seeing interest rates close to zero (although some online savings account were recently offering close to 1 percent). Don’t expect to see that change in the immediate future. It could take years before those rates follow the lead of the Fed funds rate. Expect your return on basic savings to continue lagging inflation.
You’ll be able to find slightly higher returns with a money market fund or short term CDs, just be careful not to lock up cash you might need to access.
If you’re an investor. Interest rates will have the biggest impact on fixed-income investors like retirees. Even if you’re pretty diversified, it’s worth taking a closer look at your bond allocation. As interest rates go up, yields fall. Protect yourself by shifting your bond holdings to investments with a shorter time horizon. “Longer term bonds are the ones that will be affected the most,” says Joe Franklin, a certified financial planner in Hixson, Tenn.
Offset the lower yields with less interest rate sensitive investments such as TIPs. A bond ladder can also help offset the risk of rising interest rates.
If you’re a borrower. Lock in now. If you’re looking to buy a home or refinance a mortgage, get the process moving so that you can take advantage of current rates. Even small changes in mortgage interest rates can have a big impact in the overall cost of a loan.
That’s particularly true for those in adjustable rate mortgages who may have been enjoying incredibly low payments in recent years. Locking in a fixed rate mortgage, or an adjustable rate loan with a longer time horizon may mean trading your current low payment for a higher one, but it will protect you from having to refinance in a few years when even fixed rate loans are higher. “If you have the opportunity to refinance, this is probably as good as it’s going to get for a while,” says Joe Heider, president at Cirrus Wealth Management in Cleveland, Ohio.
If you’ve got high interest debt like a credit card balance, make paying it off a priority. Slightly higher rates won’t have a huge impact on your monthly payments, but they will push that balance higher much more quickly. Look for a zero percent balance transfer and aim to pay off the debt before it expires in 12 or 18 months.
You could lose money by investing in a money market fund. Although the fund seeks to preserve the value of your investment at $1.00 per share, it cannot guarantee it will do so. An investment in the fund is not insured or guaranteed by the Federal Deposit Insurance Corporation or any other government agency. Fidelity Investments and its affiliates, the fund’s sponsor, have no legal obligation to provide financial support to money market funds and you should not expect that the sponsor will provide financial support to the fund at any time.