Your Financial Goals vs. The Fed
By Gary Silverman, CFP®
Unless you tend to pay attention to business, finance, and economic news, you may have missed that the Federal Reserve has changed tack (or changed direction for you non-sailing folk). In brief, they have said that they will not react to rising interest rates, thus allowing inflation to rise above their previous 2% target. Sound familiar? If so, kudos for you. But hearing about it and knowing what the heck it means are two different things. I’ll try to clear the waters a bit. First, to my economist friends, please accept my standard apology for glossing over most of the details in the name of simplicity.
The Federal Reserve has two main goals: To keep inflation/deflation in check and to keep people working. These two goals can and often do conflict because one of the main ways to keep inflation from heating up is to cool down the economy—and a cooled economy usually causes unemployment to rise. Lowering interest rates tends to help the economy and jobs—but that eventually leads to inflation, which erodes the purchasing power of people’s paychecks. Figuring out exactly how to balance these two conflicting problems keeps the Federal Reserve Board of Governors up at night.
We’ll mostly ignore for now how the Fed keeps interest rates low. But the point is that they have decided that their current focus will be economic growth and employment. Fighting inflation will just have to wait. (Yes, it’s because of COVID, but we’ve seen the tendency of the Fed to lean this way since the Financial Crisis over a decade ago.) Given that the main way the Fed does this is to keep interest rates low, we can assume that the low rates you see today will be around for a while. And that’s a big deal.
What does it mean for you? Well, there are two obvious answers. If you are borrowing to buy something—say a house or a car—you are going to get some historically low rates. This makes it easier to buy, putting less strain on your budget. A few things might then occur. You might save more for future needs which will help you in, well, the future. You might buy nicer, bigger, or better which makes you happier (initially), but more importantly moves money around which is good for the economy (someone got more money from you and they in turn can spend it). Or you might be the one who spends what you saved in interest, again helping the economy.
If you’re a saver, low interest rates aren’t such a good thing. You are the one getting the lower interest payments. This makes it harder for your savings account or money market to keep up with inflation and taxes. At best you are treading water when it comes to purchasing power. If you are an investor, your bonds aren’t paying near what they were a decade or two ago. Being safe is costing more return than it used to.
On the other side of the investing front, stocks, low interest rates help, which is one of the reasons the equity markets are having such a good time. There is a limit to this, however. Time will tell where that is.
Gary Silverman, CFP® is the founder of Personal Money Planning, LLC, a Wichita Falls retirement planning and investment management firm and author of Real World Investing.
