Inflation and Interest Rates: What it Means for You

It is no surprise that inflation is skyrocketing in the US. The current inflation rate for 2022 exceeds 9%. Typically, annual inflation is estimated to be about a “standard” 3%. So what has happened to cause this craziness, and what does it mean for you?

How does inflation impact consumers?

Inflation rates are directly related to the supply and demand of goods and services. Since Covid, there have been many issues in supply chains and also in labor markets, which led to less availability of things consumers wanted to purchase. The products and services we wanted were harder to get. Because of this, the prices of these goods and services rise. People are willing to pay more to purchase an item or service they want. So prices begin inflating between the increase in scarcity of resources and the increase in demand. Bottom line: It costs more money to buy less goods or services.

What does inflation have to do with interest rates?

The Federal Funds Rate is the rate at which banks allow each other to borrow money overnight. The Federal Reserve meets as needed to determine necessary base rate changes. Then, all of the other banks and lenders base their rates on these changes. If rates go up, it costs you more to borrow money. The Federal Reserve hopes this rate increase will, in turn, decrease demand for goods and services. In a perfect world, this will drive down prices and eventually slow inflation.

What should I do when interest rates are rising?

There are several financial moves worth making when rates are rising. If you have the wiggle room in your budget, keep these options in mind:

Pay down anything with a variable rate. Many credit cards, student loans, mortgages, and other loans have variable rates that will rise alongside the Federal Funds rate. If rates are anticipated to continue to rise, plan to pay these types of loans down as soon as possible to avoid additional interest.

Avoid new debt when rates are high. Avoid taking out new loans or opening new credit lines when rates are higher. Also, try to delay new home or vehicle purchases if you have to finance them. Ideally, you want to open new debt lines when rates are lower. Obviously, your financial situation might not always allow you to maneuver around interest rates, but doing what you can will help.

Get that extra cash out from under your mattress and put it to work! Many people set aside a hefty amount of cash as a safety net. The majority let this money sit in regular bank accounts, barely earning a small interest rate if any at all. People are generally ok with this because it provides them with security that the funds will be there when needed and will not depreciate in value. When rates rise, there are many options for investing in fixed-income vehicles that will provide a decent interest rate that surpasses what your cash is accumulating in a basic checking or savings account. Fixed annuities, CDs, and other interest-bearing accounts can provide safety of principal, with a good interest rate to boot.

Look at your current investment portfolio. There may be moves that can benefit you in a rising rate environment. If you work with an advisor, now might be a good time to check in and see if there are any strategic moves to benefit your portfolio, especially if you hold bonds or fixed annuities.

Inflation and interest rates are a big deal in 2022 and will continue to be hot topics in our struggling economy. As always, feel free to reach out to us here at FSG if you have any questions on how the current economic environment may impact your financial picture.

https://fsgmichigan.com/podcast/episode-64-the-old-4-rule
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https://fsgmichigan.com/podcast/episode-16-the-silent-retirement-killer-inflation

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Written by: Kristin Prieur