Here we go again: The Federal Reserve just raised the federal funds’ interest rate target for the third time this year. Now that it has happened, how might it affect your investments? Certified Financial Planner Paul Fain joins us now with five things to keep in mind.
LET’S REVIEW WHAT THE FEDERAL FUNDS RATE IS…
The federal funds rate is an overnight bank-to-bank lending rate that the Fed can use to implement monetary policy – when the Fed wants to tap the brakes on economic growth, making it more expensive for banks to borrow money from each other. Banks tend to scale back lending in turn, slowing the economy.
HOW WILL RISING INTEREST RATES AFFECT OUR SAVINGS AND INVESTMENTS?
1. Short-term fixed income investments are strongly influenced by the federal funds rate. So deposit accounts, money market funds, Treasury bills, short-term bonds, and short-term bond funds will pay a higher yield over time.
2. Intermediate- and long-term bonds may be less affected. Not all rates are going to respond to a fed funds hike in the same way.
WHAT ABOUT MORTGAGE RATES?
3. Adjustable-rate mortgages are usually tied to short-term rates, and if so they can be expected to rise. Fixed-rate mortgages generally track 10-year Treasury bond yields, and won’t necessarily move higher.
AND FINALLY, HOW WILL THIS MOVE AFFECT THE STOCK MARKET?
4. Stock markets typically rise during the earlier stages of rate-tightening cycles. As things stand now, the yield curve is flattening as short-term interest rates rise in the face of a strong economy, while longer-term rates lag slightly due to the moderate pace of inflation. Stocks have historically performed well in such conditions.
5. Rising rates underscore the importance of diversification and rebalancing. A well-diversified portfolio can help keep you from being overexposed in any single asset class. Rebalancing involves periodically buying and selling assets to bring your portfolio back to your current desired asset allocation. Make sure your portfolio is diversified and aligned with your risk tolerance and investment timeframe.
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