Entries Tagged 'Finance' ↓

What is the Federal Reserve?

The Federal Reserve is the central banking system of the United States of America.  The president appoints 9 members to the “Board of Governors”, with one Chairman of the Board (Currently Ben Bernanke, formerly Alan Greenspan.)  There are 12 Federal Reserve Banks scattered across the U.S. that are basically tools for the Federal Reserve to control the U.S. financial universe.   The Federal Reserve is an independent institution within the U.S. Government, and it does not operate in order to make a profit, however it does make enough money to cover its operating expenses.

What does the Federal Reserve do?

The Federal Reserve is tasked with the job of regulating the monetary policy of the United States, in a way that encourages low unemployment and sound economic growth.  Hmmm…sounds easy enough

What is “The Interest Rate”?

The “interest rate” which we hear so much about is actually the federal funds rate.   This rate is the rate at which banks loan money to other banks (very short-term, usually overnight.)  The fed funds rate is not actually SET by the Federal Reserve, rather it is a “market” rate.  Meaning, the price for money (rate) is determined just like anything else, supply and demand.  When the Federal Reserve announces the fed funds rate, what they are announcing is their TARGET.  The Federal Reserve then influences this rate by buying or selling Treasury Securities in the open market (just like you or I could). 

(Quick Lesson on how this works:  By buying Treasury securities the fed is taking investments out of the open market and putting cash into it.  This cash will eventually find its way into a bank.  Since the banks have more cash they will all be more willing to lend cash to one another…greater supply, less demand, the price of money (interest rate) will drop.  Obviously the opposite is true if the Federal Reserve decides to sell Treasuries)

What does this mean to me?

In very simple terms, the federal funds rate more or less directly effects the interest rates you see in your day-to-day lives.  If the fed funds rate drops significantly, you will see that you can get a pretty good rate on a mortgage or a car loan…but on the flipside you aren’t going to get much of an interest rate on your savings account.

A couple interesting facts on the Federal Reserve:

-       The Federal Reserve Bank in NY holds more gold than anywhere else in the United States.  Even more than Ft. Knox

-       Any earnings the Federal Reserve makes beyond its expenses, are turned over to the Treasury

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Flickr Credits: epicharmus

Every financially responsible man should have an emergency fund.  This is a fund you keep to cover you in the event of losing a job or some other unforeseen semi-catastrophic event (i.e. car explodes).  In this fund you should have enough to cover 4 or 5 months of living expenses.  To determine your living expenses you should look at all of your expenses in your monthly budget and cut out the extra expenses like clothes, gifts, etc…Be sure to cover this amount for 4 or 5 month.  Typically this amount should be about 2-3 months salary.

You should keep this in a high interest checking account, such as the one offered by ING Direct or HSBC.  If you click HERE this will actually gives you a $25 bonus for signing up with ING Direct (you also get a 3% APY).  Create the account, fill it up, let it sit…just in case.

One last thing…Do not worry about this money being safe.  Both HSBC and ING are FDIC insured up to $100,000.00.  (This means that the Federal Government insures you for every dollar you have in the account as long as you have less than $100,000.00, so no worries).

Please let me know if the ING Direct link does not work.

Flickr credits: _ES

One of the most basic of all Personal Finance and Investing topics, is to follow the highest interest rate.  Before you start thinking about investing or saving money, ask yourself where is the highest interest rate you have on any of your financial investments or obligations.  Do you have a credit card at 11% interest, a car loan at 4%, a savings account at 5%, a student loan at 3%?  This law is very simple…put as much money as you can towards the highest rate.  If you have credit card debt at 11%, and that is your highest interest rate, you should pay off as much of that debt each month as you can.  The next step would be to move on to the next highest interest rate, in the example above this would be the savings account at 5%.

Assume you had $500 remaining after paying all the minimums on all your payments rent/mortgage, student loan, credit card, etc.

Also make the following assumptions

• Owe $400 on the credit card (after the monthly payment has been made)
• Owe $12,000 on the student loan @ 3%

With the remaining $500 you would want to pay off the entire credit card ($400) at the high 11% interest rate.  The remaining money you would want to invest in the savings account since 5% is a higher interest rate than both your car loan and your student loan.

*This ignores the impact of taxes, however the purpose is to understand the principle of putting you’re money wherever the highest interest rate is.

Flickr credits: Gregor Rohrig