We’ve all heard about the Federal Reserve announcing an interest rate cut. But we might not know what it means for our finances.
In this article, we go over how an interest rate cut can affect our daily lives. And how we can take advantage of interest rates to save money faster.
Definitions And Explanations
But first, let’s quickly understand what the Federal Reserve role is and why we need interest rates.
Federal Reserve And Its Main Functions
The Federal Reserve, also referred to as the Fed, is the central bank of the United States. The congress created the Fed to help promote a safe monetary and financial system for our nation.
The unique goal of all three main Federal Reserve functions is to promote a healthy U.S. economy by:
- Conducting the U.S. monetary policy. They influence interest rates, money, and credit.
- Acting as a bank to the U.S. government and other financial institutions.
- Supervising and regulating banks to make sure the financial system stays stable.
An interest rate is a percentage of your loan principal. It determines how much interest you pay your lender on top of the principal. It’s the price to pay to have access money you don’t have.
The lower the probability for you to pay your debt on time, the higher the interest rate.
In general, people tend to save more and spend less money when interest rates are high. However, when interest rates are low, they tend to borrow more and save less money.
How Does An Interest Rate Cut Affect The Economy?
Depending if the economy is strong or weak, the Federal Reserve may cut or raise interest rates. The goal is to keep the economy healthy and under their control.
Most of the time, the Fed cuts interest rates when the economy slows down, or if an unexpected event disturbs it.
Cutting interest rates means loans are cheaper for people and businesses. And when things are more affordable, people tend to consume more and take on more debt.
What Are The Effects Of Low-Interest Rates?
|Loans are less expensive||People save less money|
|Businesses hire more people||People spend more money|
|Stimulates demand for real estate||People investment decisions are riskier|
|Drives the economy up||Cause inflation to increase|
How To Take Advantage Of Low-Interest Rates After A Cut?
Review Your Savings Strategy
Low-interest rates mean you earn less interest on the money you saved in the bank. You should still save money regularly, but you might need to review your overall financial strategy.
If you own certificates of deposit (CDs), your interest rate is fixed. In other words, your interest rate won’t change until your CD due date.
However, the interest rates of traditional savings accounts, high yield savings accounts, and money market accounts will go down.
A great strategy is to only keep enough money in these accounts for your emergency fund. And the rest of it should move into other investment tools.
Invest Your Money in Mutual Index Funds
Low-interest rates are a good sign for the stock market. Since loans are cheaper, companies tend to take on more loans to increase their business.
An excellent way to take advantage of this situation is to invest in mutual index funds. Because when interest rates are low, the economy tends to grow. So with the right investment strategy, you will enjoy high returns.
Mutual index funds are great investment tools to add to your portfolio. By definition, they allow you to diversify your positions. And if you follow the dollar cost averaging method, you should be set for the long term.
Refinance Your Loans
Low-interest rates mean loans are less expensive. If the interest rate cut is significant, you might want to refinance your mortgage. You can save a lot of money by making the right financial moves.
Another way you can take advantage of the situation is to consolidate your debt. It can be a great idea to take on a low-interest rate loan to pay off your high-interest loans.
Credit card interest rates tend to go lower as well. However, since credit card debt is the worst debt you can carry, you should avoid them at any cost.
Low-interest rates mean better opportunities for loans. But keep in mind that debt can be dangerous for your finances. If you are not 100% sure about what you are doing, you should get help to figure it out.
Don’t take on more debt even if you think that loans are on sales.
What Are The Effects Of High-Interest Rates?
|People save more money||Loans are more expensive|
|People pay down their debt faster||Consumer demand decreases|
|People spend less money||Increases business layoffs|
|Cause inflation to decrease||Slows the economy down|
How To Take Advantage Of High-Interest Rates After a Raise?
Reduce Your Spendings
High-interest rates mean you can’t afford to take on more debt. And the best way to not have to take new loans is to reduce your spendings.
First, you need to calculate your monthly expenses. Then you need to create a budget. Budgets are great financial tools that help you track and reduce your spendings.
The less money you spend, the more money you save and invest.
Invest Your Money in Low-Risk Investment Accounts
High-interest rates increase the interest you can earn on low-risk investment accounts. For example, traditional savings accounts, high yield savings accounts, certificates of deposit, and money market accounts.
Changes in interest rates are a great time to reassess your investment allocations. Depending on your risk tolerance, you might want to prioritize low-risk investment accounts.
Assess Your Debt
You can think of interest rates are the same for debt, savings, or investments. In other words, it doesn’t matter if your investment returns are 5% if you have a credit card debt with a 15% interest rate.
Keep in mind that sometimes the best investment for you can be to pay off your debt.
But when interest rates are high, your low-risk investment returns can be better than your loan interests. If it’s the case, you might want to double down on your savings. Because your savings can pay your loan interests.
In conclusion, when the Federal Reserve announces an interest rate cut, it’s important to understand the reason behind it.
It can be a great opportunity for the economy to grow. Or it can also mean that our economy is collapsing and it’s the last shot we have to avoid a recession.
No matter the reason, you need to think long term. If you stress about your investment fluctuations, you might not be at peace with your current financial strategy. Take this opportunity to review your strategy and make a few changes.