Compound interest investors and mortgage borrowers have something in common: They are both “rate hunters” who keep an eye on the market for conditions they can take advantage of. Homeowners who carry a mortgage on their properties will look for signs of lower interest rates so that they can apply for refinancing; the opposite takes place among compound interest investors who look for financial instruments that pay higher rates.
The Impact of Federal Reserve Interest Rates
In the United States, interest rates are set by the Federal Reserve Bank; these rates form the basis of lending operations and represent how much banks have to pay when they tap into the credit lending facilities of the Treasury and other government agencies. To this federal funds rate, banks add another 3% to set the prime rate, which is typically the lowest interest they will charge on loans, mortgages, and credit cards. With regard to savings and money market accounts, the rates that banks will offer are usually lower than the fed funds rate, which in early 2021 was almost negligible for compound interest investors.
compound interest investors should be on the lookout for more enticing high-yield savings accounts
Higher fed funds rates are more attractive to compounding investors, and this is what many economists believe will take place during the administration of President Joe Biden. When national economies recover, the usual reaction of the Federal Reserve is to raise interest rates. This is not good news for mortgage borrowers and credit card holders, but it opens a window of opportunity for investors who apply compound interest strategies to their portfolios.
With the prospect of higher interest rates on the horizon, compound interest investors should be on the lookout for more enticing high-yield savings accounts. At the same time, certificates of deposit and some municipal bonds should prove to be more attractive. As for stocks, Wall Street investors tend to dislike higher rates because companies end up having to pay more for commercial loans, so we should not be surprised to see the stock market cooling down over the next couple of years.