Keeping a portfolio with a healthy mix of assets that are properly diversified may allow you to weather market shocks more easily.
How Interest Rates Can Impact Your Portfolio
There are reasons to pay attention to the Fed’s Open Market Committee (FOMC) meetings, which are held eight times per year. Much of the focus is on the Fed’s position on interest rates. Every word from the Fed is parsed, and for understandable reasons: Interest rates can affect the direction of the markets, an individual security and the economy.
Ostensibly, the FOMC meetings serve as a guide for the direction of short-term interest rates. But what does that mean to you? We’ll review how interest rates could have a direct impact on your investment portfolio.
Impact on Your Investment Portfolio
The difficulty of anticipating interest rate movements helps illustrate the importance of developing and sticking to a diversified investment plan.
For starters, the Fed controls just one set of short-term interest rates;* generally, the movements of longer-term rates – anything beyond a couple of years – effectively are set in the borrowing marketplace. Economists and Wall Street experts who are trained in understanding the movement of interest rates have a difficult time projecting where rates are going.
“Trying to predict what the Fed might do, and how the markets will react, can be challenging,” said Joe Correnti, senior vice president of brokerage product at Scottrade. “For long-term investors, it makes sense to have an understanding of interest rates, but it might not make sense to make a lot of changes to a well-diversified portfolio based on where you think rates are headed.”
Impact on the Economy
When the Fed lowers interest rates, the primary objective is to stimulate the economy, in part by making it easier and less expensive to borrow. For example, home buying tends to increase as interest rates move lower. Conversely, the Fed will raise interest rates in the hopes of heading off inflation, which can result from an overstimulated economy.
Impact on Securities
- Fixed-income. The price of a bond typically rises when interest rates fall. When interest rates rise, bond prices usually fall. So if the Fed is moving through a period of reducing short-term interest rates, in general bond prices are likely to rise. If the Fed is moving through a period of raising short-term rates, bond prices are likely to fall. However, if you hold individual bonds to maturity, you typically will get all of your principal back.
- Equities. The impact of interest rate movements are less obvious or consistent when it comes to stocks. For example, although the stock markets – at least initially – tend to react negatively to rising interest rates, some sectors actually perform better with rising interest rates.
Impact on Savings and Borrowing
- At the most basic level, the Fed’s short-term interest rates serve as a barometer for rates that you might get through a bank checking or savings account or a money market account. The lower the Fed rate, the lower the rates you’re likely to receive.
- For borrowers, higher rates can lead to higher borrowing costs. For example, if you have an adjustable rate for a credit card or mortgage tied to the prime rate, your rate could increase if the Fed raises its short-term rates.
Question: Have interest rates affected your investment portfolio over the last year?
Next Step: Scottrade clients can review their portfolios by logging in to their accounts and using the Portfolio Review Tool.
*The Fed controls the Fed funds rate, which is the interest rate that banks or similar institutions charge other banks for unsecured short-term loans (typically overnight) to help meet Federal Reserve requirements.
Keep in mind that while diversification may help spread risk it does not assure a profit, or protect against loss, in a down market.
Bonds involve risks including, but not limited to interest rate risk, reinvestment risk, inflation risk, call risk, liquidity risk, credit risk, market risk, default risk, event risk, and a risk of loss of principal. New issue offerings are sold by prospectus or offering circular available at www.scottrade.com. Investors should read these carefully.
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Before you can achieve success in your financial portfolio, you should consider setting clearly defined investing goals.
Scottrade Brokerage President Peter deSilva was drawn to the firm by its client-first approach. This approach was demonstrated with the company named “Highest in Investor Satisfaction with Self-Directed Services” by J.D. Power.