What a Fed Interest Rate Hike Will Mean to You

The U.S. Federal Reserve (Fed) has refrained from raising interest rates, but eventually it will do so, perhaps even by the time you read this. And whatever the timing, a hike will affect millions of Americans in many ways.

The Fed cut its target for interest rates to zero in December 2008 to help stimulate the economy as it struggled in the depths of the Great Recession.

But the economy is in much better shape now, and keeping interest rates low for too long can cause other problems. So many expect the Fed to act soon.

A rate hike won’t affect you overnight, but eventually, it will – particularly if you use a credit card, have a savings account, invest in the markets, or want to buy a home or car.

Consider mortgages. The average interest rate on a 30-year fixed-rate mortgage has been hovering around 4 percent, down from 6 percent 10 years ago and 7.5 percent 20 years ago, according to the St. Louis Fed. So if you’re in the market for a mortgage (or other kind of loan), you may want to act sooner rather than later.

Bondholders may also be disappointed. As interest rates rise, new bonds will be issued with higher interest rates, making older bonds with lower interest rates less valuable. Of course, if you hold your bonds to maturity, you’ll still get face value.

Stock markets also may be more volatile. In many cases, a rate hike will cause investors to pull their investments out of developing economies and put their cash in what they perceive to be safer assets such as U.S. government bonds.

So if you own stocks or stock funds, the months around a rate hike could be turbulent.

Savers, however, may have reason to smile. If you’ve worried about low interest rates on your savings accounts and certificates of deposit (CDs), these will begin to move in a more positive direction.

Balancing Risk and Return in Saving for Retirement

Investing always necessitates balancing risk and return, and that challenge becomes even greater as you near retirement: you have to invest aggressively enough to build a nest egg that can support you for the rest of your life, but also insulate yourself from market turbulence that could set you back years. How do you choose a mix of investments that will deliver comfortable returns while offering the downside protection you need?

There’s no right answer, as different investors will tolerate different trade-offs. But you may want to start by determining your actual risk tolerance: think seriously about how low the value of your nest egg can drop before you exit the stock market.

To do that, consider how different asset allocations would have performed from 2007 to 2009 (market high to market low). Without rebalancing, a portfolio of 70 percent stocks and 30 percent bonds would have lost around 40 percent; a portfolio of 50 percent stocks and 50 percent bonds, 26 percent; and one with 40 percent stocks and 60 percent bonds, 19 percent.

Once you’ve determined an appropriate asset allocation based on risk tolerance, you can move on to part two: developing a stock-bond mix that has a good chance of delivering the returns that will enable you to maintain your preretirement standard of living throughout your retirement. You can do this with a retirement income calculator.

Of course, if the portfolio you’re comfortable with in a market downturn doesn’t provide the growth you need, you’ll need to reevaluate. And this is where your advisor can be a great support.