Making Sense of Changing Interest Rates
How Interest Rates Can Influence Financial Decisions

How Interest Rates Can Influence Financial Decisions

Spread the business risk with changes in interest ratesMost of us aren’t too worried about interest rates, and not many of us will lose sleep over a little change in rates, but there are few aspects of an economy that have as much effect on spending and savings as Interest Rates.

Taken at face value, the Reserve Bank meetings on the first Tuesday of every month may only bring a bit of angst if directly affecting our Mortgage Payments. And adjusting interest rates up or down, may seem to be a simple solution for steering the country’s economy:

Are we growing slowly or stagnating?     Cut interest rates.
Are we growing too quickly?                     Raise interest rates.
Economy seems fine?                                Leave well enough alone.

The reality is that there are few mechanisms in any economy that can influence the behaviour of those living there more effectively than interest rates.

Have a think about how low interest rates have affected important financial decisions in your own lives…

Low interest rates often create great incentives for people and businesses to spend up, especially on purchases that require financing. Interest rates directly affect the cost of borrowing, so lower rates help increase the affordability of items like cars and property. Most of us would have noticed that home sales tend to be higher when mortgage rates are at 5% than when they are at 10%.

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The primary motivation for cutting interest rates is usually to stimulate us to spend. Lowering rates encourages businesses to purchase capital goods and equipment; and home owners might just lash out on items that were previously out of reach.

Alternately, higher interest rates reduce the incentive to spend and we again see the potential benefits of saving. In theory, higher interest rates dampen consumer demand.

If the supply of goods and services remains the same, the result should be less pressure to put prices up – which basically means, less inflation.

When rates are low, investors often take higher-risk in their investments to receive a greater return potential. Over long periods, more investors may be in riskier positions until too many resources are exposed to too much risk. The more economic resources spent pursuing speculative investments, the greater the risk of financial catastrophe.

For now, we’re likely to see low interest rates remain. When it comes to your own investment portfolio, it’s quite important to strike a balance between making decisions based on long-term interests and on the current influence of interest rates.

Building a Business Versus Building Wealth

I’ve found that many women love the idea of running their own business and embrace becoming self-employed. Whether by starting in party plan sales, working from the home computer, taking on a franchise or helping others in small business; most love the idea of flexibility and family time opportunities that small business represents. There’s also the thought that maybe sale of the business down the track can help pay off debt or even assist with retirement funding.

That said, the market for small businesses has been hardly ideal in the past few years and some are struggling more than ever. Many are still just closing the doors and walking away, amidst much debt and heartbreak.

The reasons for the lacklustre market may be due to external forces:

* Weak economic conditions mean some businesses are earning less so not enough money is coming in

* Tighter lending standards reduces the pool of eligible buyers so it's much harder to find a buyer for the business; and

* Qualified buyers may be waiting for a stronger economy before assuming more risk so there's a better chance they'll make money by buying the business.

In other words, efforts to build a successful business may not always translate to an increase in your own personal wealth.

One way that may help insulate your personal financial situation from the fluctuating small-business market is by investing outside your company. Many pour all their profits back into their own company, but external investing can have some important benefits. For example, if you were forced to sell unexpectedly, (perhaps due to illness or relationship changes) your post-business lifestyle wouldn’t the depend 100% on the final price of sale. You might also be better able to withstand low offers if you are in a position to wait for the right buyer.

Eggs and Baskets

Think of it as diversification. We’ve all heard ‘don’t put all your eggs in one basket’ and allocating too much personal wealth to one company, even if it is your ‘baby’ can be a risky proposition. Diversification, or spreading the risk, does not eliminate the possibility of investment loss; however it is a great way to help manage risk.

It’s natural to want to believe that all the love, effort and dedication you pour into your business will help increase the selling price, but there’s always the risk that it won’t. So try and take your ‘owner’s’ hat off and look from the outside in, to see all possibilities and spread the risk and make money from other sources.

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Find out about Amanda Cassar

Find out about Amanda Cassar

Guest Writer Amanda Cassar of Wealth Planners Partners

Amanda Cassar of Wealth Planning Partners has a passion for creating financial freedom and believes it's possible for all of us.

Amanda has been involved in the finance and insurance industry since 1991. Her particular passion is making sure all families have adequake risk strategies in place to protext what they're already worked so hard for, and then look to wealth creation for the future.

Amanda has recently completed her Masters in Financial Planning (MFP) and is a Telstra Business Women's Award Network member. She is a mum of two teens, enjoys good food, great wine and travel - and loves living on the beautiful Gold Coast. 

You can find more financial knowledge and wisdom through the Wealth Planning Blog and Wealth Planning Partners Facebook online resources.

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