Investing Spotlight: The Impact of Interest Rates on Your Finances

Interest rates have remained historically low over the past decade. But that's beginning to change. After leaving the federal funds target range near 0 percent from December 2008 to December 2015, the U.S. Federal Reserve (Fed) raised the rate 0.25 percent in December 2015, December 2016, and March 2017 to its current target range of 0.75 percent to 1.0 percent. And, the Fed is expected to continue raising rates gradually over the next few years. How do rising rates affect your finances, and what should you do to prepare?

Rising rates will lead to higher interest rates on your savings. But with rates so low, you may not notice a big difference for some time. While you may see a blip in the rates for bank deposits, money-market funds, or certificates of deposit fairly soon, interest rates for stable value funds (an investment known for preservation of capital that is available in some employer plans such as 457s) tend to lag slightly behind Fed changes.

You could eventually pay more for your debt. Rates for 30-year fixed mortgages have already increased slightly, and rates are likely to rise at the reset date for adjustable-rate mortgages. If today's rates are still lower than the rate on your mortgage, see if you can benefit from refinancing your mortgage.

Credit-card rates tend to rise faster when interest rates increase, and it may become more difficult to find attractive balance-transfer offers after rates rise. If you're thinking about transferring to a lower-rate card, be careful about fees and aim to pay off the balance before the lower rate expires. See the Manage Your Debt article for more information.

When interest rates rise, bond prices tend to fall because people can buy new bonds with higher rates. This can affect the returns on bond funds, which may decrease, at least temporarily, when interest rates rise. But not all types of bonds are affected the same. Short-term bonds, for example, tend to be less sensitive to interest-rate movements than longer-term bonds. If you're comfortable with the risk exposure of your portfolio, then you may not want to make changes just because interest rates rise.

Interest rate increases don't necessarily damage the stock market. If rates are rising primarily because of a stronger economy, then the stock market generally performs well. If rates are rising primarily because of inflation fears, then the stock market may stumble. Again, if you're comfortable with the risk exposure of your portfolio, you may not want to make changes just because interest rates rise.

The changes in interest rates and their impact on the economy and financial markets underscore the importance of maintaining a diversified portfolio that matches your time frame and risk tolerance, and not trying to time the stock or bond market.

When you have decades to go before retirement, it's usually a good idea to invest more money in stock funds, which generally have more volatility over the short term in return for the possibility of larger returns over the long run. But it's important to start dialing back risk as you get closer to retirement and start withdrawing money. When retirement is just a few years away, some advisers recommend keeping three to five years' worth of cash needs in an investment that generally isn't subject to market risk, such as a stable value fund. This is in addition to the normal three to five months of living expenses in an emergency fund, which should also be in cash. Such an additional safety net will protect you from having to sell stocks in a down market.

You can build a diversified portfolio on your own, or you can use a target-date fund in which investment professionals create a diversified fund that gradually shifts to be more conservative as the retirement year in the fund's name gets closer. To learn more, see Choose Your Approach.

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