While dining with a friend recently, we were meandering around issues both big and small when talk turned toward the debate over whether the Federal Reserve will raise interest rates.
She responded with, “I think they will raise rates, don’t you?” I agreed, and we moved on to discussing upcoming Thanksgiving plans.
After a few minutes, she paused and confessed, “I don’t even know what it means, ‘rates rising.’ I act like I know, but I haven’t a clue.”
My friend is not alone. Many investors get caught up in all the buzz and feel compelled to take action without first fully understanding the implications of rising rates, and how market events could affect them personally.
Let’s back up just a bit and examine three steps you can take to make sense of the current rate environment, understand how it relates to your investments and decide whether you should take action or just sit tight.
Step 1: Understand How Interest Rates Work
First, take this time to read up on interest rates, monetary policy and the markets.
You probably already know that interest rates are the costs of borrowing money. And they can really vary when you compare the rates you’re paying on your credit card to your car loan to your mortgage… and then to the paltry return you receive from the bank on your savings account.
Why do they vary so much? Because there are different types of interest rates. Learn the differences and understand the answers to questions such as:
- What is the Federal Reserve (aka “The Fed”), which interest rate does it control, and what goes behind the board’s decision to either raise or lower it?
- Why do more expensive loans affect some business sectors more than others?
- Why do my bond prices go down when the interest rates go up?
- How do rising interest rates impact the overall economy?
Get started by taking a look at some of the recent market analysis written by my colleagues.
Step 2: Reduce Your Cash Hoard
When the markets get volatile and the financial news static gets too loud, many people just give up and cash in. But if you still have years to invest, you will not come out ahead once you figure in taxes and inflation (even at our persistently low inflation rates).
Rather, the recent volatility may mean bargains for some really good companies. Also, certain sectors, such as U.S. technology and financials, historically outperform during rising rate cycles. And consider looking to bond ETFs with short maturities, which can provide better returns than cash for a little more risk, while also reducing the interest rate risk that comes from longer-maturity bonds. So consider this period as a buying opportunity to strengthen your stocks and defend your bonds, while also reducing any cash surplus.
Step 3: Cut Through the Noise
I understand it can feel a bit overwhelming, especially when you start reading news headlines about volatility, growth worries and markets in a tizzy.
But pause and remind yourself that investing is personal, and what matters most are your own investments and your own goals. This is a good opportunity to take a fresh look at your investments and reassess your timeline. If you open the hood and realize that you already have a carefully allocated, well-positioned, diversified collection of investments, it’s OK to do nothing. Close the hood.
If you see opportunities to make improvements, then use this shift in market winds as a catalyst to make some thoughtful—not headline driven—changes. Rather than try to time the market with specific company stocks or bonds, consider ETFs, which offer broader exposure to general sectors, global markets and bond maturities.
In either case, make sure the noise isn’t driving investment decisions—you and your long-term goals are.
We all know that interest rates affect us. Understanding how they relate to monetary policy, the markets and ultimately, your investments, can empower you.