This is Part 2 of my Investing for Beginners Series. If you have any retirement/investment questions, please ask below or e-mail me and I will make a future post. Or e-mail me to guest post on investing. I always love hearing about what others have to say.
Interest rates affect individuals in many areas. Maybe you just got a great mortgage interest rate and instead of paying 6% interest, you’re now paying 3%. Or maybe you’re like me and you just got a great car loan rate at 0.9%.
It’s easy to calculate the amount of interest that you’ll earn by having your money in a savings account.
Interest rates are the cost of borrowing money. It is the return for the service and risk of lending money. When you deposit your money into a bank account, usually (hopefully) you want some sort of return. Without interest rates, individuals would not be want to lend and would have less reasons to save their money.
An example would be when you buy your house. You are borrowing money for the house and the bank needs some sort of return, so they charge you an interest rate (since they are giving you a service and there is risk.
I know a lot of people think interest rates are the death of everyone and mankind, but I don’t always believe so. If you get a really low interest rate on your house or car, then you can throw this money (instead of paying for your house or car with cash) towards the stock market and other investments. You can probably earn a higher return then if you would have paid something off with cash if interest rates are low.
And this is the main reason for why we took out a car loan instead of paying for the Jeep with cash.Our cash earns a higher rate in multiple areas instead of paying extra on a car loan that has such a low interest rate.
How do interest rates affect savings?
Interest rates affect many areas of the economy and your financial life such as:
- The stock market.
- Your investments.
- Your retirement.
- Your savings.
- Your purchases.
Interest rates affect the stock market, which can play a big role in the amount that you are able to save for retirement and everything else. Interest rates and the stock market move in opposite directions:
- If interest rates go up, then individuals are more likely to save in less risky assets. When interest rates rise, you don’t have to invest as much because you get a higher yield on your funds and don’t look for increased risk.
- However, if interest rates go down, then individuals are more likely to invest in the stock market, as they believe their return in the stock market will be higher. Also, when interest rates decrease, individuals are forced to set aside more money so that they can keep their retirement plan on the correct path in order to reach their end goal.
Bank account rates can affect your savings. In your actual savings account, you may only have your emergency fund, but over time, every little bit counts. However, in your overall retirement savings and investment accounts, interest rates can greatly affect the amount that you are able to save.
Household savings tend to decline with low rates. If rates are low, individuals are more likely to spend the money that they have because they are getting a small return on their money. Household savings also generally decline with low rates because borrowed money cost individuals less than it would if interest rates were higher.
There are also, of course, inflation risks with your money. If your interest rate is lower than inflation, then you will be losing money, due to the time value of money.
So if your interest rate is 2% and inflation is 3%, in the long run, you will be buying less with your money.