What do Rising Interest Rates Mean for You?

January 19, 2016

 

JER WW PHOTO

A client asked me the other day about interest rates and how they could impact his savings. For a long time, whenever the Federal Reserve had its monetary policy meetings, the big question in the media was: Will they raise interest rates? It’s a valid question. Since the Great Recession hit, the Federal Reserve has used monetary policy to keep short-term rates very low—close to zero, in fact. The idea behind the policy has been to get people to spend rather than save, and to drive money into “risk” assets such as stocks, which should help the economy.

But with the recession technically over, the Federal Reserve has now pulled the trigger. They announced a ¼% rate increase at the December 16, 2015 meeting. Why did they do this? Here are a couple of key reasons:

• If the economy continues strengthening, continued low rates could jump-start inflation.

• If the economy were to go into a new downturn with rates where they are now, the Federal


Reserve would have trouble responding. The usual remedy for a downturn is to lower interest rates. But that would be difficult if rates are already near zero.


There’s no law saying rates must rise, of course. Japan, for instance, has had low rates for a couple of decades. But they’ve also had a very sluggish economy during that time, not something the U.S. is looking to emulate.


If additional rate increases are coming, look for it to happen gradually. Federal Reserve Chairperson Janet Yellen has said as much. The positive side is that savers will see interest payments to their savings accounts, CDs and money market funds increase. Likewise, newly issued bonds will pay higher rates. But the duration of your bonds, the time until they mature, should be kept relatively short in a rising-rate environment. This is so you don’t get locked into a bond paying an old rate, unable to take advantage of new (higher-rate) bonds as they are issued.


If problems with inflation develop, bonds which are indexed to inflation, such as Treasury Inflation-Protected Securities (TIPS), are a good low risk investment. Stocks and Real Estate Investment Trusts usually make good hedges against inflation as well.


So my final message to the client who asked about interest rates, and to anyone wondering the same thing, is to put your mind at ease. Returns can still be made in rising-rate environments. There may be a little volatility in the markets now that the Federal Reserve has made its move. But a quarter-of-a -percent rise in short-term rates isn’t that big of a deal, though the markets might try to make it one. Eventually, expect relief from the markets that the move has finally been made. It shows that the Federal Reserve has confidence in the recovery.


If you’re young, you can plan to ride out any volatility. If you’re nearing or in retirement, with much of your money already in bonds, the volatility should not affect you as much. Either way, it’s important to us at PARTNERSINWEALTH that you remain organized and in control of the situation. If you’re uncomfortable about something you’re seeing in the news, don’t hesitate to call us so that we can discuss how it impacts your specific circumstances. Please contact Jim Waters, CFP®, at 713.964.4028 or jrw@partnersinwealth.com.