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What to do with your money during rising interest rates

The Federal Reserve announced on Wednesday that it would raise benchmark interest rates by three-quarters of a percentage point and indicated more hikes were to come.

The increase is the third consecutive 0.75 percentage point move and the fifth increase in the past six months — all part of a central bank’s attempt to cool runaway inflation. All told, the series of hikes has pushed Federal Funds interest rates to a range of 3% to 3.25%, the highest since 2008 and from near zero to start the year.

You’d have to go back to 1981 to find a six-month period when interest rates rose more. The numbers were a little more extreme then: From late July 1980 to January 1981, Federal Funds interest rates bounced from 9% to a dazzling 19%, according to the Federal Reserve Bank of St. Louis.

With interest rate hikes on the rise, it’s worth taking a look at how they affect your finances and how financial experts say you can adjust your savings, spending and investment strategies.

Prioritize paying off debt

The Fed’s measures make it more expensive to borrow, as the interest on various forms of consumer loans is linked to the interest of the federal funds.

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“You’re stepping into an increasingly strong headwind as interest rates rise,” Greg McBride, chief financial analyst at Bankrate, told CNBC. “Credit card rates are the highest since 1996, mortgage rates are the highest since 2008, and auto loans are the highest since 2012.”

Further rate hikes will not affect any fixed rate car loan you may have, and the same goes for fixed rate mortgages. However, if you have a credit card balance, the rate you owe on that money will continue to rise in addition to the short-term rates set by the Fed.

With the average card currently charging an interest of 18.16%, according to Bankrate, taking action as soon as possible is essential.

“The interest you save by paying off debt is like making an investment with the same after-tax return with no risk,” said Lisa Featherngill, national wealth planning director at Comerica. “If your card has a 22% interest rate, that’s the same as earning 22% on your after-tax investment.”

Credit card rates are the highest since 1996, mortgage rates are the highest since 2008, and car loans are the highest since 2012.

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Greg McBride

Chief Financial Analyst at Bankrate

If you can’t pay off your debt quickly, transferring your debt to a balance transfer credit card can keep you from paying interest on your outstanding balance for 6 to 21 months.

Other options for easing your high-interest debt include consolidating your debt under a low-interest personal loan or signing up with a credit advisory service.

“If you have more than $5,000 in debt, these can be really beneficial,” Ted Rossman, senior analyst at Bankrate, told CNBC Make It.

Increase the interest you get on cash in the bank

A silver lining of an environment with rising interest rates is that saving becomes more lucrative. Well, depending on where you make the savings.

While interest rates on deposits tend to correlate with increases in the fed funds rate, you’re still probably making next to nothing on your savings. Bank of America, Chase, US Bank and Wells Fargo each offer a 0.01% annual rate, according to Bankrate. All in all, the national average rate on savings accounts is just 0.13%.

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However, there are deals to be had with online banks, with different interest rates north of 2% and even 2.5% on savings accounts.

That may seem cold consolation to savers sustaining inflation north of 8%, said Kelly Lavigne, vice president of consumer insights at Allianz Life. “In this environment, if you have cash on the sidelines, you’re going to lose money,” he says.

Nevertheless, financial professionals recommend keeping enough cash to cover at least three to six months’ worth of living expenses in an emergency fund: “That way, if the worst happens, you’ll have enough to cover your bills,” he says. And even if the current interest on your cash reserves doesn’t keep up with inflation, making something with your money is better than making almost nothing.

Choose wisely for investments, think long term and ‘don’t panic’

If you’ve looked at your portfolio during the recent rate hike regime, you’ve probably noticed that your stocks and bonds don’t seem to be big fans of higher rates. The S&P 500 is down about 20% so far this year as investor fears have mounted that the Fed’s efforts to slow inflation could send the economy into recession.

Bonds, traditionally viewed as a less volatile counterweight to equity portfolios, weren’t much better. As bond prices and interest rates move in opposite directions, bond indices flipped in 2022, with the Bloomberg Barclays US Aggregate Bond Index down more than 13% on the year.

If you’re a long-term investor in stocks, “you want to make sure you don’t panic,” Lavigne says. “It can be hard to buy when the market is down. Better keep making periodic investments and not try to time the market.”

Bond investors, meanwhile, would be wise to monitor the average maturity of their portfolio, a measure of interest rate sensitivity. In general, longer-term bonds have longer maturities, meaning they will decline in value more in response to interest rate hikes. Short-term bonds tend to hold up better during rising interest rate regimes.

One investment everyone should consider, at least according to Suze Orman: Series I bonds. These bonds, issued by the Treasury and simply referred to as “I bonds,” pay a fixed interest rate over the life of the bond plus an interest rate linked to changes in inflation. If you buy before the end of October, you will receive an interest rate of 9.62%.

There are a few catches. Among them: they cannot be redeemed within 12 months of your purchase date, and you will incur a penalty equivalent to three months of interest if you cash out at any point in the first five years you hold the bond. The bonds must be purchased directly from the Treasury’s website and you cannot invest more than $10,000 per person per calendar year.

Because investments are complicated, it’s smart to consult a financial planner before buying, says LaVigne. “No one should go all in on a particular investment without talking to a financial professional first.”

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