How do interest rates affect retirement savings?

What are interest rates and who sets them?

Interest rates are the rates financial institutions such as banks charge customers to borrow money. The U.S. Federal Reserve (Fed), the U.S. central bank, is responsible for the country’s money system, including setting interest rates.

The Fed meets eight or more times per year to set the federal funds rate, which is the basis for interest rates charged by banks and other financial institutions. After the Fed changes the federal funds rate, you’ll usually also see a change in the rates you pay on mortgages, student loans, car loans, and credit cards. 

Why are interest rates going up?

One of the main reasons interest rates are rising is because inflation is rising. As prices go up, it may be harder for you to manage your spending, and it’s likely harder for businesses to manage theirs as well, which can cause trouble for the economy.

To help slow down inflation, the Fed can step in to stabilize prices—and one of the tools it has is raising interest rates. When interest rates go up, fewer people and businesses borrow money, which means less demand for goods and services, which in turn helps to lower prices.

Because inflation is rising so quickly these days, the Fed is aggressively raising interest rates. They started with an increase of a quarter percentage point (0.25%) in March, and there may be six more increases before the end of 2022.¹

Although that change may not seem like much, it can have a big impact on your personal finances, both your debt and your savings.

Be aware of variable interest rates and credit card debt

Any debt you carry will charge either a fixed or a variable interest rate: Fixed interest rates stay the same throughout the life of the loan; variable interest rates generally change when the Fed raises rates. And when rates go up on your loan or credit card, you pay more to borrow that money. Some examples of variable rate loans include:

• Credit cards
• Home equity lines of credit
• Adjustable rate mortgages
• Other loans, including student loans

Look at all the debt you carry. If any of your loans or credit cards have a variable interest rate, you might consider calling the issuer to see if you can change it to a fixed interest rate before rates go up again. If you can’t, perhaps shop around for lower-interest or fixed interest-rate credit cards and loans, and see if you can take advantage of offers to transfer credit card balances to a zero-rate balance transfer card. 

How rising interest rates might affect your retirement savings

When interest rates go up, they should also increase the amount you earn on your savings, checking, and other interest-earning accounts. Although the increases aren’t usually as much as you’d hope, every bit helps—especially over the long term. Whether you have a long way until retirement or it’s just around the corner, you may want to consider adjusting your retirement plan investments.

• Cash and cash-like accounts—No matter how much time you have until you retire, consider shopping around to make sure you’re earning the best possible rates in your interest-earning accounts, such as:
  • Savings accounts
  • Checking accounts
  • Certificates of deposit, or CDs
  • Money market funds

• Bonds and stocks—As a general rule, when interest rates are low, many people and companies invest in stocks rather than bonds in the hope of better returns in the stock market. But as interest rates go up, investing in bonds becomes more attractive—especially for people nearing retirement. The closer you get to needing your retirement savings, the more conservative you may want your investments to be. When interest rates were very low, you may have stayed in the market in the hopes of improving your earnings. But with interest rates going up, it may be a good time to consider moving some of that money into bonds.

The economy and the state of your personal finances depend on many factors—and interest rates are an important one. Knowing how rising interest rates can affect your debt and your savings can help you understand the latest headlines and perhaps take advantage of changing economic conditions.

1 https://www.federalreserve.gov/monetarypolicy/fomccalendars.htm, federalreserve.gov, 2022.