Investors, traders, savers and homebuyers - young and old - were fixated on last week's Federal Reserve interest rate announcement, especially in the wake of recent market volatility. While they chose to let the economy sit tight for now, it's only a matter of time. We've been living in a stimulus period of historic lows in interest rates, and when the Fed does make a move, it will be the first rate hike in almost a decade. While low rates have been great for borrowers, they haven't been so great for savers. Student loans, auto loans and mortgages have seen the benefits of low interest rates. As for savers, this low-rate environment has been harder to handle. That's especially true for retirees who depend heavily on the income they generate to sustain the lifestyle they worked hard for. So what do investors, both old and young, need to be aware of when the Fed raises rates later this year or in 2016?
For savers who are investing for long-term goals like retirement or those who are already retired and reliant on fixed income streams, it's important to understand interest rate hikes (or lack thereof) through the lens of total return. There could be some initial dips, but over time, it may be likely that your portfolio will equalize, leaving you in a better spot than if you would have divested during any tumultuous periods following a hike. It's not all bad news; these rate hikes, even though the media hypes them up so much, have a silver lining for individuals who are close to or in retirement. Of course, it is important for bond holders to be aware of the risk that an increase in rates could cause the lower-rate bonds they currently hold to lose value.
It's also important for young investors - those who likely weren't invested in the markets during past rate hikes - to understand that when the Fed raises rates, they will still be extremely low by historical standards. Earlier this year, CNN Money pointed out, "Even if the Fed raised rates by only 0.25 percent in September and again in December, they'd still be below one percent. Rates were above four percent during all of 2006, a year that saw the S&P 500 rally more than 13 percent."
In this low-interest-rate environment, young investors may be tempted to play the "waiting game," hoping to take advantage of future, presumably higher interest rates on bonds or CDs. Although it may not be advisable for investors to always be 100 percent invested, or perhaps they haven't yet accumulated a lot of wealth, waiting to invest could still result in lost income. The longer your money sits static, the higher rates will have to go to make up for what you missed while waiting. If interest rates stay low and you are a younger investor with cash on hand and a long time horizon, instead of focusing only on bonds and CDs, consider keeping an eye out for buying opportunities among stocks during market dips. You may be able to add lower-priced stocks to your nest egg while others fret.
At the end of the day, any long-term investor should remember that interest-rate policy is not a fine tool. It usually takes between six and 12 months for the economy to feel the effects of lower rates. It also takes time for the economy to slow down as a result of higher rates. Yes, things will likely get shaken up in the short term. The unwinding of a stimulus is bound to be a temporarily volatile event. But just like you shouldn't sell low during market rides, you shouldn't panic when interest rates rise. It's a small disruption that has been inevitable.
For individuals who are focused on retirement and other long-term goals, stock investors may continue to rely on company fundamentals. Take this time to advance your financial and investor education, and don't hold out for interest rates to rise. Most importantly, have a plan before interest rates do rise. The average investor is not able to time the market effectively, and that holds true for stock market ups and downs, as well as interest rate ups and downs, so a well-diversified portfolio is typically the best defense against market movements.
Investments in fixed income products are subject to liquidity (or market) risk, interest rate risk (bonds ordinarily decline in price when interest rates rise and rise in price when interest rates fall), financial (or credit) risk, inflation (or purchasing power) risk, and special tax liabilities. Investments in fixed income products are subject to market risk, credit risk, interest rate risk, and special tax liabilities.
TD Ameritrade, Inc., member FINRA/SIPC. Stock investing is subject to risks, including risk of loss. Commentary provided for educational purposes only. Past performance of a security, strategy, or index is no guarantee of future results or investment success.