20s: Build The Foundations
20s: Build The Foundations
Understanding Interest Rates And How They Affect Our Money
by The Gloss
For new investors in their 20s, gaining a clear grasp of interest rates is an important part of building financial awareness. Interest represents the cost of borrowing money, and changes in interest rates influence everything from loan repayments and savings returns to economic growth and investor behaviour. By understanding how interest rates work and why they fluctuate, you can better navigate financial decisions and strengthen the foundation of your investing knowledge.
Interest, in simple terms, is the price you pay to borrow money from a lending institution. The interest rate is a percentage of the original amount that is loaned, called the principal amount. A loan at 6.5% per annum will naturally cost you less over time then a loan at 8% per annum.
Why are interest rates important?
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Interest rates are extremely important to the financial system. In a sense, they dictate the value of money itself. The lower interest rates are, the more likely people are to acquire loans. If interest rates are too high, people will not be able to afford the loan repayments and will be far less likely to borrow. This means less consumer spending, less new business, and far less economic growth. At the same time if credit remains cheap, and there is too much economic growth (see the year 2008 for reference!) it becomes like a runaway train that will eventually crash. High interest rates can curb excessive borrowing or prevent the potential of asset bubbles.
Who sets interest rates and why?
The European Central Bank (ECB) sets interest rates for the Euro area. Setting interest rates appropriately keeps economies on an even keel. By moving interest rates up or down central banks can regulate activity, stimulate growth, and maintain price stability.
Exchange Rate and Global Trade
When a country’s interest rate is high, it becomes more attractive to foreign capital. There is an increase in exchange rates, a stronger currency and exports become more expensive. Lower interest rates make a currency less appealing and exports much cheaper. Currently the world’s strongest currency is the Kuwaiti dinar (KWD). You will get 0.36 Kuwait dinar for one Euro. The world’s weakest currency is the Iranian Rial, where one Euro will get you 45525 rials.
Investor behaviour
When interest rates are low, banks want consumers to spend rather than save, so they do not offer much interest on savings. Bonds also don’t offer great returns when interest rates are low, leading investors to seek out equities. Recently, with interest rates on the rise, there has been a bigger move to bonds from investors. When interest rates rise, investors will move more of their capital from stocks to bonds.
Rising inflation = rising interest rates
: During periods of high inflation, central banks around the world raise interest rates to reduce demand and spending. This brings prices back to affordable levels. At the same, time centrals banks must be careful not to increase interest rates so high that consumers are put off borrowing and spending entirely, thus plunging the economy into recession.
Mortgage interest rates
Mortgage interest rates vary from country to country due to factors such as inflation, economic growth, monetary policies, the bond market, and the stability of the housing market within that country. In Nordic countries, interest rates are overall lower due to the financial stability of its borrowers.
As you begin your investing journey, remember that interest rates will shape markets, and some of your financial decisions, for decades to come. They influence everything from bond returns to stock market sentiment, which means you’ll feel their impact throughout your life as an investor. The key is staying organised: keep your finances in order, understand your goals, and build a balanced, long term strategy. With a solid foundation, you’ll be ready to navigate interest rate swings and stay on track toward your financial future.
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