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If youre curious how lower interest rates affect the economy and your investments, one key economic measure to watch is the federal funds rate. Thats the rate banks charge when they lend money to other banks.

The federal funds rate is one of the Federal Reserves most important tools for fighting inflation or stimulating the economy, because it helps control how banks lend. This, in turn, has a trickle-down effect on how businesses and consumers finance their purchases.

• When inflation is too high or increasing too rapidly, the Federal Reserve may raise rates to help slow the economy and trim inflation. In general, higher interest rates will mean slower economic growth, as fewer people buy and fewer companies expand.
• Conversely, when the economy is doing poorly, the Fed may cut rates to help trigger spending and thus promote stronger growth.

What lower rates could mean for your finances

A diversified portfolio designed to match your risk tolerance, time horizon, and investing goals is generally the best long-term strategy, regardless of market conditions. Still, there are a few things you can do to position your portfolio for a drop in interest rates.

Retirement investments

In any time of market extremes, its wise to check on your asset allocation. If you are a retiree heavily invested in bonds, low interest rates may mean lower returns. You may want to consider making some adjustments in spending.

Savings accounts, money market accounts, and certificates of deposit

Although rates that currently are in effect for existing CDs will not change, rates for new CDs or those coming up for renewal may be lower. In general, falling interest rates mean you may have to do more research to find the best deals.

Mortgage payments, home equity lines of credit, and home equity loans

Mortgage rates arent directly linked to the federal funds rate, but historically they generally have tracked together over time. Relief depends on the type of mortgage you have. If you have a fixed-rate mortgage, it will not change due to lowered interest rates. If your adjustable-rate mortgage (ARM) is due to reset this year, youll see a payment reduction. If you have a jumbo loan, tied to slower-moving indexes, an immediate reduction is unlikely. Regardless of your loan type, significant changes in interest rates make it wise to calculate the potential benefits of refinancing.

Variable rates on home equity lines of credit almost always follow the prime rate, so those interest rates should drop and lower your payments. However, home equity loans, typically 10- or 15-year fixed-rate loans, are not likely to change.

If you have an existing car loan, its unlikely youll see relief because those rates are typically locked in at the time of purchase for the three- to five-year loan period. However, if youre looking for a car loan now, you may be pleased by lower rates.

Credit cards

The prime rate, which credit card companies base their variable rates on, almost always moves in lockstep with the federal funds rate. You may save a little, but nothing huge since, ideally, your credit card balance is small. However, rate cuts present an opportunity to renegotiate your current rate, transfer your balance to another card with a lower rate, or consider taking out a low-interest home equity loan.

Generally, the Federal Reserve expects lower interest rates to boost consumer spending. If you are financially prepared to make a major purchase, these rate cuts could work to your advantage. But remember that lower rates alone are no reason to increase your credit card debt. Before you jump into an all-out shopping spree, first consider how it might affect your ability to save for your long-term financial goals.

Keep in mind that investing involves risk. The value of your investment will fluctuate over time and you may gain or lose money.