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Interesting interest rates

Q: What makes interest rates go up and down?

A: Interest rates are strongly influenced by inflation and the debt market (think Treasury notes, bills, bonds, etc.). Inflation has been low in recent years, averaging about 3 percent annually over decades. Interest rates have started inching up but are still below average. After all, the prime rate topped 20 percent in 1980.

When the economy appears to be growing too briskly, the Federal Reserve can slow growth and keep inflation in check by hiking short-term interest rates via the “federal funds” rate — the rate a bank can charge another bank for use of its excess money. The Fed also sets the “discount rate” — the rate banks pay it to borrow short-term funds. When the economy is sluggish, the Fed will often try to juice it by lowering rates, encouraging companies and people to borrow (and spend!) money.

The prime rate, mortgage interest rates and other interest rates are often directly or indirectly influenced by the federal funds rate or the discount rate. The money markets themselves (basic supply and demand for credit) also exert great influence over interest rates.

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Q: I’ve saved a little money, and I want to invest in stocks. What do I do?

A: First, pay off any high-interest-rate debt and fund an emergency account with at least several months’ worth of living expenses. Meanwhile, read up on investing. Perhaps start with Joel Greenblatt’s “The Little Book That Still Beats the Market” (Wiley, $25) or John Bogle’s “The Little Book of Common Sense Investing” (Wiley, $25).

Conventional not-so-wise-dom

Dear Fool: My biggest financial blunder was listening to conventional wisdom about diversification.

Many years ago, I was living in Austin, Texas, where Dell was based. Dell was growing like gangbusters and was about to go public.

Meanwhile, my portfolio was already heavily weighted with shares of Compaq Computer, which was performing well for me. I heeded the old adage to not have too much money in a single industry, so I passed on the Dell shares. I could have made many times my initial investment in it, had I bought some shares.

I learned it’s more important to invest in businesses you’re very familiar with than to blindly follow conventional wisdom.

The Fool responds: The conventional wisdom isn’t that silly, as plenty of industries have been hit hard at various times. The airline industry, for example, could get whacked by soaring fuel prices, while pharmaceutical companies might suffer if some reform limits how high they can set prices. If you were that excited about Dell and also wanted to remain invested in Compaq, you might have sold half your Compaq shares and put that money into Dell.

It’s also worth noting that investing in initial public offerings (IPOs) can be tricky, and it’s often best to wait a year or so for the stock to settle down. Usually only the most connected investors get the actual initial shares, with others buying at higher prices.

A prescription for profit

Shares of CVS Health (NYSE: CVS) have had a tough year, dropping in large part due to fears about Amazon’s potential entry into the pharmacy business. Bears worry that Amazon will leverage its access to big data and its vast online retail network to essentially crush CVS Health’s all-important pharmacy-services segment, which generated a whopping $33.2 billion in revenue during the second quarter of this year.

But this fear is almost certainly overblown. CVS Health has an entrenched competitive position that won’t be easily overcome by any would-be competitor — even Amazon. Its latest quarter featured pharmacy prescription volume at stores open more than a year jumping 9.5 percent over the previous time last year, helping drive overall revenue up 5.7 percent. Contributing factors include continued success for CVS Health’s patient-care programs, alliances with health plans and other pharmacy benefit managers, inclusion in more Medicare Part D networks and higher brand drug prices. Many investors also like the same-day drug-delivery service that the company is rolling out in many cities and have high hopes for its planned merger with Aetna.

CVS Health’s shares have recently been trading at attractive levels, with a forward-looking price-to-earnings (P/E) ratio near 10. The stock also sports a dividend that recently yielded 2.6 percent. (The Motley Fool has recommended CVS Health.)