HOW RISING INTEREST RATES will affect you depends on whether you own money or owe it. For people with significant investments, returns will likely improve; for people with debts, the hole is about to get deeper.
Unfortunately, when rates go up, as they did this week, people tend to act like animals-the proverbial deer caught in the headlights, the chicken that just left its head on the chopping block or the overindulgent pig at the trough.
Just as those behaviors aren't particularly healthy for the animals, neither are they good for people trying to get the most for or from their money.
"No matter what someone's situation is, making dramatic changes today is a mistake," said Harold Evensky, a partner in the Coral Gables, Fla. financial planning firm: Evensky, Brown & Katz. "People have short-term memories and tend to forget how much money they lost the last time this happened, and they rush out and did things that they regretted later.
Just how you should react to rising interest rates depends on individual circumstances, but the best advice is to look for sensible opportunities to improve your finances. Here are some maneuvers to consider or to wait on:
The most immediate impact of the rate hike will come in the next monthly statement sent to about half of the nation's credit card holders, nearly all of the people with home equity loans and about 15 percent of homeowners.
Those are the folks whose payments are based on a variable rate of interest and whose bills are about to get bigger.
As a result, the increase in interest rates puts a premium on paying off debt, preferably in the following order: credit cards, (because the interest rates are highest) unsecured personal loans, auto loans, home equity loans and mortgages.
This is the time to respond to one (or more) of those annoying mailers offering a low-interest credit card because the savings compared to an existing high-rate account are about to get even bigger. Even with the hike in interest rates, the best credit cards offer rates of 10 percent or less.
"Get your interest rate reduced, get you balance transferred to a card that is better, get you credit card company to drop its annual fees-threaten to leave them if they don't-because if you don't do it, things are going to get worse for you," said Marc Eisenson, who publishes the consumer newsletter, The Banker's Secret Bulletin.
(If you aren't getting regular solicitations from every credit-card issuer east of the Mississippi, you might send for an issue of CardTrak, a newsletter that offers a comprehensive list of the best deals on low-rate, no-fee, secured and gold cards. Copies sell for $5; mail to CardTrak, c/o RAM Research Corp., Box 1700, Frederick, MD 21702.)
Consolidating your debt is another attractive option, especially if it can be done at a low rate or with the tax deduction that comes with a home equity loan. With rates rising, the return on money poured into debts will be greater and likely will outstrip the return available on many investments.
As for homeowners, chances are good that the rate increase wipes out hopes for refinancing into something better, with the exception of homeowners with adjustable-rate mortgages. Depending on the terms of the variable mortgage, consumers may find an attractive loan although it may take a further increase in rates (something some experts believe will happen early next year) to drive adjustable rates that high.
Experts agree that people currently in the process of buying a home should lock in their mortgage rate immediately in hopes of beating increases. Prospective homeowners, however; may want to reconsider. As interest rates rise, the rate of return on a home tends to shrink and the benefits of home ownership become less attractive compared to renting.
Rising interest rates also make it less attractive to aggressively pay off a mortgage. While there is always benefit to reducing debt, the savings from paying ahead on a fixed-rate mortgage remain static, compared to the returns on investments in certificates of deposits and bonds.
Look to get out of low-return savings NOW and money-market accounts, but don't lock your money up for too long.
"Stay fairly liquid in money funds and Treasury bills because rates are probably going to keep going up over time," said Walter s. Frank, chief investment officer for IBC/Donoghue Inc. of Ashland. "See what you can get out of the economy now; and in January or February, you can decide if you want to stay in the liquid mode or start locking things up."
Returns on certificates of deposit are up dramatically this year, out-stripping a lot of the more-heralded market- based investments. Short-term Treasury securities and the best money-market accounts provide returns just a little bit better.
The result is that an investor can improve returns while waiting the interest situation out, rather than reacting-like the headless chicken and making long-term moves based on the Fed's short-term maneuvering.
"The last time rates were this high, people jumped and locked into long-term CDs and bonds," said Evensky, "but they had all of their money tied up in that stuff; and when it came due, they couldn't find a decent place to put it. They faced reinvestment risk and lost."
"If someone wants to lock in some of the better returns that are going to be out there now, that's fine; but they shouldn't just dive right in with everything they've got.
The other temptation, when interest rates rise, is for investors to pursue bond funds on the assumption that these mutual funds will show improved performance. Generally however, bond funds perform better when interest rates decline. The rule of thumb in the rising interest rate market is that bonds - rather than bond funds - deliver what they promise and return principal in tact. Bond funds do not always meet that standard.
While most financial advisers stop short of suggesting a withdrawal from a bond fund, they warn against adding more money to bond funds now.
One other caveat is not to get greedy when looking at the yields being offered. If a money-market account or bond fund has a yield that is much higher than its peers, the investment probably carries more risk. Most advisers suggest looking for a good short-term return complete with some measure of safety.
And if investment in the financial markets seem too complicated or risky, experts warn against rushing into collectibles as an alternative. Traditionally, collectible markets heat up along with interest rates, if only because people want to have tangible assets.
The trouble with collectibles is that they favor people who already own them, not prospective buyers, during hot market times. The increased demand causes prices to rise, and the hike in interest rates makes it more expensive - relative to the return you could get on cash - to hold the assets.
"People are more likely to buy into collectibles when the market is at the top, which is exactly the wrong time to buy," said Bret Leifer of Bret Leifer Numismatics of Wayland. "People like collectibles when interest rates rise, but it's not something they should be doing with a lot of their money. Just like anything else right now, they shouldn't rush into it."