On June 14, 2017 the Fed announced its fourth increase in their interest rate targets in the past 18 months. Are the interest rate increases we’ve been threatened with for the past 5+ years finally here? If so, this this begs the question(s), what areas of our lives are affected by movements in interest rates and what are some things to consider in increasing and decreasing environments?
Increasing rates have effects on two main areas, interest-bearing accounts & investments, and liabilities.
Shorter-term investments like Certificates of Deposit (CDs) or interest-bearing bank accounts can definitely be affected. If rates are on the rise and you are looking at using a CD for some of your money, consider shorter-term CDs so as not to lock in the lower rates for a longer period of time. CDs in a period of rising rates can have interest rate risk. While CDs have principal protection, the risk is the opportunity cost of being locked in to an interest rate that is lower than is available on the open market.
Bonds are a whole different animal. Generally, unless you plan to hold individual bonds to maturity, increasing interest rates may cause a decrease in value of the bond investments held. Some types of bonds are more sensitive to this decrease than others. The opposite is true during periods of time when interest rates fall, increasing the value of existing bond holdings as new similar bond issues will pay a lower coupon.
Liabilities, especially those with variable or adjustable rates, are also impacted by movement in interest rates. For example, think about if you hold an adjustable rate mortgage and interest rates were to fall. This should decrease the interest rate charged resulting in a lower monthly payment. If interest rates rise, this would have the reverse effect on your payment. Adjustable-rate loans or lines of credit may be beneficial in a decreasing-rate environment. Consider reviewing the terms on a line of credit and your ability to pay it down proactively or refinance to a fixed-rate when rates are on the rise.
While these are general principles, it’s always best to discuss the affect changes in interest rates can have on your unique situation with a professional.