Pros and Cons of Interest Rates Going Up
The Federal Reserve recently announced that interest rates are going up in 2017. It’s not that this came as any surprise. As Akin Oyedele points out in the article, I just linked to, “This move, which markets saw a 100% probability of” was always just a matter of time.
Amongst other things, interest rates going up will lay to rest a decade that saw unprecedented monetary policy and give the economy the room it needs to grow organically.
However, that doesn’t mean that interest rates going up are going to be a good thing for everyone. There are various pros and cons to consider. Let’s take a look at the most notable examples of each.
Your Investments Will Be Worth More
It’s impossible to generalize everyone’s portfolio, but for most, interest rate hikes mean better returns. This is especially true for those invested in bonds. If you’re not, now would be the time to do so in order to take advantage of interest rates going up.
Better still, I’d recommend using a bond ladder for your retirement funds. By lining up staggered maturity rates, you are ensured a constant stream of income over the course of a predetermined amount of time. You get reliable payouts and can use your returns to keep the ladder going.
Secondly, the stock market is most likely going to be in for some volatility, at least in the short term. Dayanna Yochim, Hal M. Bundrick, and Tony Armstrong all point this out in, “What the Fed Rate Hike Means for Your Money”:
“When a rate increase is expected (as this one has been for many months), the effect on the overall market is usually baked into stock prices already, at least partially. It’s reasonable to expect at least a bit of short-term stock market anxiety in response to the news, since Wall Street is notoriously easy to spook. Intermittent volatility in exchange for higher potential returns on your long-term savings is par for the course. The stock market’s post-election dive and quick turnaround race to all-time highs is just the most recent example.”
I’m still a much bigger fan of bonds, but it’s worth pointing out that your stock market portfolio isn’t necessarily in jeopardy just because the coming months may be a bit dicey.
Your Savings Will Take a Hit
On the other hand, it’s impossible to deny that, yes, your savings are going to suffer as interest rates go up. This will happen for two reasons. The first is that, with interest rates going up, inflation is going up. In simplest terms, inflation is when the price of goods and services go up, and the power of currency goes down.
Therefore, inflation hurts your ability to save because you need to spend more money just to keep up with your expenses. It now costs more for gas, food, electricity, etc.
Not only are you able to save less, but, over time, you may need to dip into your savings more and more. That’s why interest rates going up actually damage your current nest egg. Unless you’ve been living well below your means this entire time, it’s unlikely your savings will get to remain at their current level as interest rates go up.
Lending Is Back
Given the source of the economic problems that wreaked havoc on the entire world for the past decade, it’s understandable that lending practically came to a standstill as the Federal Reserve raised interest rates.
We’re finally going to see that change, though. The drought of lending is coming to an end. Banks will, once again, have a greater incentive to lend out reserves at higher interest rates.
Furthermore, aside from what this will do for individuals, the increased flow of additional credit could also do a lot for overall economic growth in our country, something that has been stagnant over the last couple of years.
Healthcare Is Going to Cost More
One truly frightening effect of interest rates going up is that the cost of long-term care insurance skyrockets. This is the type of insurance that covers essential services like nursing care, adult day care and assisted living – things that make a huge difference where the quality of life is concerned.
Jesse Slome, the executive director of the American Association for Long-Term Care Insurance, explains how higher interest rates make long-term care more expensive:
“Lower rates have wreaked havoc on long-term care insurance costs,” he says.
As interest rates fell, insurers saw the return on their investments slip. For every 1 percent decline in rates, insurers have needed to hike premiums by 10 percent to 15 percent, according to Slome.
Consumers may have been tempted to delay buying long-term care insurance while they wait for interest rates to rise. But that strategy has carried risks.
“Twenty-four hours from now, your health can change,” Slome says.”
More Buying Power Overseas
Finally, as we mentioned earlier, we should see our country’s economy start to grow with the help of interest rates going up. One collateral benefit will be that we should also enjoy better leverage when buying goods from other countries because of an improved exchange rate.
This is especially good news for people who enjoy traveling. Most of us will benefit in one way or another because so many of our purchases involve foreign products or services, but if you’re planning a trip abroad, you should be even more excited.
As Dean Baker, the co-director of the Center for Economic and Policy Research, has said about higher interest rates:
“[It’s] likely to mean a somewhat higher dollar, so people traveling to Europe will do well.”
Obviously, we have a long way to go before we’ll get to see the actual results of interest rates going up. As you can see, there are both pros and cons involved with this decision. However, if you prepare for both, you should have an easier time benefiting from the good and avoiding the bad.