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The Federal Funds Rate and How It Affects You

The Federal Reserve sets the guardrails for the federal funds rate, and through that helps control the money supply for the nation.

"Federal Reserve Building in Washington D.C. - Illustration" byDonkeyHotey is licensed underCC BY 2.0

When you take out a loan for a car, charge something to your credit card, or get a personal line of credit, there is going to be an interest rate that applies to your loan.

A lot of different factors go into what you will be charged, including your own personal credit score. But even those with flawless credit still see a minimum charge that they can't get around. That all goes back to the Federal Funds Rate.

One thing consumers rarely realize is that all of our banks are lending money to each other every night. Banks are legally required to maintain a certain percentage of their deposits in non-interest-bearing accounts at the Federal Reserve to ensure they have enough money to cover any withdrawals that may unexpectedly come up. However, deposits can fluctuate and it's very common for some banks to exceed the requirement on certain days while some fall short. In cases like this, banks actually lend each other money to ensure they meet the minimum balance. It's a bit hard to imagine these multibillion-dollar financial institutions needing to borrow money to tide them over for a bit, but it happens every single night at the Federal Reserve. It's also a nice deal for those with balances above the reserve balance requirement to earn a bit of money with cash that would normally just be sitting there.

The Federal ReserveThe Federal Reserve


The exact interest rate the banks will charge each other is a matter of negotiation between them, but the Federal Open Market Committee (FOMC) (the arm of the Federal Reserve that sets monetary policy) meets eight times a year to set a target rate. They evaluate a multitude of economic indicators including unemployment, inflation, and consumer confidence to decide the best rate to keep the country in business. The weighted average of all interest rates across these interbank loans is the effective federal funds rate.

This rate has a huge impact on the economy overall as well as your personal finances. The federal funds rate is essentially the cheapest money available to a bank and that feeds into all of the other loans they make. Banks will add a slight upcharge to the rate set by the Fed to determine what is the lowest interest that they will announce for their most creditworthy customers, also known as the prime rate. If you have a variable interest rate loan (very common with credit cards and some student loans), it's likely that the interest rate you pay is a set percentage on top of that prime rate that your lender is paying. That's why in times of low interest rates (it was set at 0% during the Great Recession), a lot of borrowers should go for fixed interest rate loans that won't increase. However, if the federal funds rate was relatively high (it went up to 20% in the early 1980's), a variable interest rate loan may be a better decision as you would be charged less interest should the rate drop without the need to refinance.

The federal funds rate also has a major impact on your investment portfolio. The stock market reacts very strongly to any changes in interest rates from the Federal Reserve, as a lower rate makes it cheaper for companies to borrow and reinvest while a higher rate may restrict capital and slow short-term growth. If you have a significant portion of your investments in equities, a small change in the federal funds rate can have a large impact on your net worth.

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The best ways to improve your credit score

Deciphering the factors that contribute to a credit score and the ways to improve that magic financial number might seem intimidating, but achieving the great credit score of your dreams is a somewhat simple matter of discipline and attention.

Whether your score is poor or on the verge of great, you know you want to improve it because you've already checked it. Understanding what constitutes your score means more than knowing the number, though. There are three major bureaus that report your credit: Equifax (yes, that Equifax), Experian and TransUnion. It's smart to check all three reports annually for errors or inaccurate information.

A credit score is based on payment history, credit utilization, length of history, credit mix and the amount of inquiries on your accounts.

Some of these factors are worth more than others and the two highest-weighted factors are your payment history and credit utilization. To optimize your score, you'll need to manage all of these factors carefully. Here are the best tips to improve your credit score.

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Are You Ready for a Credit Card?

Depending on who you talk to, the words, "credit card" mean one of two things: "danger zone" or "freedom, baby!" Having a credit card is both a blessing and a curse. Yes, it can encourage you to spend a little more freely without having to feel the burn right away, but it can also give you a rude awakening when you receive your monthly bill.

Let's take it back to 1920s America. It was the era of flappers, great jazz, and modern-day conveniences, like movies and cars. More leisure time and new financing options like generous bank loans and buying on credit, made people spend well beyond their means. For nearly a decade, everyone was buying like crazy. But unfortunately, that came to a tragic halt in October of 1929. Bummer.

Since then, the United States has ebbed and flowed in moments of economic prosperity and recession. But one practice that all Americans can do is establish responsibility with their credit. And responsibility is not necessarily something that everyone has once they turn eighteen and can legally apply for a credit card.

To qualify for a credit card, you must have a steady source of income that will prove to your bank that you can pay your bills on time and not drown in credit card debt. If you're so inclined to start early, there are special student or retail credit cards that may have easier qualifications. (Yes, you can still apply for a credit card if you have no credit.)

The most important thing to understand when you apply for a credit card is that it gives you a high risk of debt. But, if you are able to pay your bills on time, you can build your credit and qualify for greater purchases down the line. You'll have to have a strong credit score to buy a house, apply for a mortgage, or even to seek employment in certain domains. You can achieve this by starting off strong. Know your limitations by crafting a thoughtful budget. Here's a great budgeting resource to get you started.

While debit cards take money out immediately from your account, they don't help you build credit. To see if you're ready to pay a monthly credit card bill, total up all of your expenses month to month, and find the average. Then, see if you can save that amount every month. But the best way to get started is to find out as much information as you can. If you think you're ready for a credit card, then you need to figure out which card will be best for you.

Are you ready? Put your credit card knowledge to the test with this quiz!

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Investment and Financial Strategies for Recent College Graduates

Hats (or shall we say "caps") off to you recent college grads! After years of hitting the books and acing (or at least passing) your exams, you're now ready for "the real world." Part of being a post-scholar is smart money management, so investing and using your money strategically is important not only for your current place in life, but for your future. These tips will give you the know-how to make wise money-related decisions that you may not have learned in school, but may be even more valuable (pun intended) than what you're professors had to offer.



Start a 401(k)

While retirement may seem a long way off, planning for your golden years is best started as soon as possible. One way to do so is by opening a 401(k) retirement plan with the company you work for once you land your first post-college job.

As per U.S. News & World Report, "Even if you can only afford $25, $50 or $75 a month, there are several benefits to starting right away. The benefits of compounding could turn your small monthly investment into a decent nest egg as time passes. Even if you put $50 a month into your plan during your first year of employment, that $600 in contributions alone could grow into $13,952.08 over 40 years. Plan to increase your contributions as you get older, but for now, contribute as much as you can as soon as you can."

Plus, many employers will match your contribution up to a certain percentage. It's like getting free money! Forbes notes, "If possible, invest enough in your 401(k) to qualify for the full match (the amount your employer puts in as a result of how much you contribute). Most employers require workers to save between 4 and 6% of pay to get the maximum match. Whatever the match, try to take your company up on it." Not to mention, contributions are tax-deductible and the money grows tax-deferred until you take money from your savings.



Deal with Student Loans

College is expensive, and many students take out loans with hefty interest rates in order to afford to pay for school. U.S. News & World Report recommends, "If you have student loans (and most students do) pay them down at a rate faster than you're obligated. Putting extra money toward your student loans while you can, before you take on other large financial obligations, will be invaluable down the road."

Forbes adds, "Adding an extra $25 to your monthly repayments can shorten the life of your student loan and save you interest. Making the payments through automatic debits from your bank account can reduce the interest rate, too, according to student-loan servicer Sallie Mae."

There's also the option of a government (federal) consolidation loan. As per U.S. News & World Report, "With a consolidation loan, you are able to bundle all of your federal student loans into one monthly payment. Often, your rate will be lower than the average weighted rate of your existing loans. When you consolidate, your monthly payments may also decrease. By owing less interest and having a lower monthly payment, you are able to put more money away into savings."

Plus, according to StudentLoans.gov, you can do this at no cost to you. And, as per Nerdwallet, "Your payments will be tied to your earnings and your loan balance will be forgiven after 20 or 25 years."




Clear Your Credit Balance

Using a credit card may be your only option at times, but getting rid of debt, or clearing it completely, if possible, is best started now before the debt keeps piling up. U.S. News & World Report suggests, "If you acquired a student credit card while in college, it's time to graduate to a low-rate card."

Also, try to pay more than the minimum required each month, even if it's just by a few dollars. Over time, the payments will add up and debt will diminish. Forbes recommends, "Adding an extra $25 to your monthly repayments can save you interest. Making the payments through automatic debits from your bank account can reduce the interest rate, too." (If your card is through your personal bank).

Most of all, try not to accumulate credit cards and lower your spending if you can right after college. Make a budget and stick to it. As per Young Money, "The best way to stay in the driving seat of your finances is to create a personal spending budget. Be sure to factor in such things as taxes, increases in prices (i.e. gasoline), and other possible changes due to economic factors (i.e. inflation). In other words, practice conservatism-plan on the worst, and be prepared for the best."



Invest Your Money

While you may think that the period right after college should be the time to focus on making money and putting it straight into your bank account, investing some of it can be a smart plan. Forbes notes, "No, it's not too soon. In fact, one of the great advantages you have over people your parents' and grandparents' age is that you have many, many years ahead of you, which means more time for your money to grow. And, historically, buying stocks or mutual funds is the best way to do this."

U.S. News & World Report agrees, "Devise a strategy incorporating several different types of investments that allows you to diversify in order to reduce risk. Now is the time to be more aggressive. You can gradually reduce the risk level of your investments as you approach retirement."

You can seek out advice online or with an advisor, which is a wise idea before making any major moves.

OK grad… you made it through those four grueling years, now it's time for the rest of your life!


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