What are interest rates?
It’s easy to know how much something costs. An item contains a price in dollars and cents, and that’s what you pay if you want it. A bottle of soda? About $1.79. A pair of noise-cancelling headphones? Let’s say anywhere between $50 and $200. The higher the number, the more expensive the item.
But what if the item you need is money? How much does money cost?
This is something that people and businesses come up against all the time. You need money to go to college, buy a car, or purchase a home. Businesses need money to expand, hire, and grow. All these things probably require borrowing money. Interest rates are what determine how much that money will cost.
In other words, interest rates are the price of money. The higher the interest rate, the more expensive the money. When you borrow money, you pay interest. But when you invest, you could be receiving interest too, so higher rates can be a good thing.
You’re probably already familiar with paying interest.
If you’re like most college grads in America, you took out student loans to pay for school. And you probably borrowed that money from a bank or other financial lender. They charge interest, stated as a percentage of the amount you borrowed. And each time you send a monthly payment, you pay off some of the amount you borrowed and some of the interest.
When you send in that last payment, you’ll have paid off all the borrowed amount and all the interest.
When you’re investing, you can collect interest, too.
When you’re investing, the roles are reversed. Now, it’s businesses or governments that want to borrow money from you. And they’ll generally pay you interest (or earnings) to do it.
Rather than going to banks, a business or government can issue corporate bonds or government bonds. Bonds are just agreements to borrow money. They stipulate the amount they want, the rate of interest they’ll pay you, and for how long they would like to borrow the money. Unlike your student loans, the corporate bond only pays interest over the life of the bond. Then at the end of a bond’s term, the company pays you back the borrowed amount. This is like you paying only the smaller interest payments every month on your student loan, but then in 20 years, paying back the full amount all at once.
If your 401(k) or mutual fund investments hold anything called “fixed income,” you’ve probably got access to bonds in those accounts. And those bonds can provide income in the form of interest payments. Because bonds can provide regular income, they’re usually seen by investors as more stable than stocks.
So, are you collecting interest?
- Check out your 401(k) or other investment statement and see if there’s anything in your portfolio called “fixed income” or “bonds.” If there is, you’re a lender. If you have an account with Principal, log in now to check.
- You can find out more about interest rates and investments in our regular economic news.
- And if you have questions about interest rates, fixed income, or investments, you can reach out to your financial professional. If you don't have one we can help you find a financial professional.
Investing involves risk, including possible loss of principal.
Asset allocation and diversification does not ensure a profit or protect against a loss. Equity investment options involve greater risk, including heightened volatility, than fixed-income investment options. Fixed-income investments are subject to interest rate risk; as interest rates rise their value will decline.
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