Vail Daily column: How can the Fed’s actions affect you?
Now that the Fed has raised interest rates, what does it mean to you, as an individual investor?
First of all, it’s important to understand just what is meant by “raising rates.” The Federal Reserve, or the Fed, directly controls short-term interest rates, although, through various measures, it can also affect long-term rates. Typically, the Fed will lower short-term rates to stimulate the economy. Conversely, the Fed will raise rates to slow down the economy if it seems to be “overheating” and threatening to push inflation to excessive levels.
Since the end of 2008, when the financial crisis hit, the Fed has kept short-term rates close to zero. But now, following several years of reasonably strong economic growth, the Fed has decided to raise rates.
Avoiding Potential Shocks
Fed chairperson Janet Yellen has indicated that further increases will be spaced out enough to avoid potential shocks to the economy. Still, as an investor, you need to be aware of the potential impact of any interest rate increase. So, consider the following:
Review your bond holdings. As short-term rates rise, shorter-term bonds, and even some cash instruments, may eventually become more attractive than longer-term bonds, which tend to be more volatile. A sell-off of longer-term bonds can push their prices downward, so make sure these bonds don’t take up too large a percentage of your fixed-income portfolio.
Build a bond ladder. A bond ladder may prove beneficial to you in all interest-rate environments. To construct this ladder, you need to own bonds and other fixed-rate vehicles, such as certificates of deposit of varying maturities. Thus, when market interest rates are low, you’ll still have your longer-term bonds, which typically pay higher rates than short-term bonds, working for you. And when interest rates rise, as may be the case soon, you can reinvest your maturing, short-term bonds and CDs at the higher rates. Be sure to evaluate whether the bonds or CDs held in the ladder are consistent with your investment objectives, risk tolerance and financial circumstances.
Be Prepared for Volatility
Be prepared for volatility. Certain segments of the financial markets don’t like interest rate increases — after all, higher rates mean higher borrowing costs, which make it harder for businesses to expand their operations. Therefore, depending on the composition of your portfolio, be prepared for some volatility as rates start moving up.
By taking these steps, you can help contain the effects of rising interest rates on your own investment outlook. Ultimately, as an investor, you need to concentrate on those things you can control, no matter what the Federal Reserve decides to do. And that means you need to build a diversified portfolio that reflects your goals, risk tolerance and time horizon. Maintaining this type of focus can help you no matter where interest rates are headed.
This article was written by Edward Jones for use by your local Edward Jones financial adviser. Edward Jones and its associates and financial advisers do not provide tax or legal advice. Tina DeWitt, Charlie Wick, Kevin Brubeck, Dolly Schaub and Chris Murray are financial advisers with Edward Jones Investments. They can be reached in Edwards at 970-926-1728 or in Eagle at 970-328-4959 or 970-328-0361.