The Federal Reserve recently raised its benchmark federal-funds rate by 0.75%. This is the largest increase in over 30 years and was done as part of their efforts to curb the high inflation the U.S. is experiencing in 2022. This increase is part of a series of rate hikes the Fed had previously announced to help curb inflation.
What are the implications of the Fed’s rate hikes and what should you be considering for your own finances?
High interest debt
Paying off high interest credit card and other debt has always been a good financial move, but it is even more important with the prospect of further interest rate hikes. This is a good time to take steps like debt consolidation or refinancing this debt into a lower cost loan. Taking advantage of balance transfer offers at a lower interest rate can also be a good idea.
For those with an adjustable-rate mortgage, this might be a good time to lock in a fixed-rate mortgage. While rates on fixed rate loans are higher due to the Fed move, it is likely that we will see continually increasing rates on adjustable mortgages.
As the Fed has raised interest rates we’ve seen an increase in mortgage rates. This makes buying a house more expensive due to the higher payments that come with a higher mortgage interest rate.
So far the hot housing market across the country doesn’t seem to have cooled off very much. Continued Fed hikes could change this and impact both buyers and sellers. Buyers need to decide how much house they feel they can afford with the current interest rates and in some cases they may have to scale back the type of home they consider for purchase.
Sellers need to consider how their local housing market might react to higher rates over time. Will these higher interest rates dampen the demand for housing? They also need to consider the impact on their plans if this includes purchasing another property to replace the one they are selling.
Rebalance your portfolio
The Fed’s interest rate hikes, along with the inflation that the Fed is trying to quell, have contributed in large part to the steep stock market declines we’ve seen so far in 2022.
It’s important to have a long-term investing strategy. A key part of this strategy for most investors is their asset allocation. This is the percentage of their portfolio allocated to stocks, bonds and cash. Beyond these major categories, you will likely have an allocation for sub-asset classes such as large and small-cap stocks, growth and value, domestic and non-U.S. holdings as well as one or more varieties of bonds. Ideally your planning includes target percentage ranges for each type of investment.
When the stock market experiences a downturn, coupled with weakness in bonds due to rising interest rates, it’s important to review and if needed rebalance your portfolio back to its target range by asset class.
Rebalancing should occur across your portfolio, including taxable accounts and retirement accounts like IRAs or a 401(k). Rebalancing can be done by buying and selling investments, directing new money to asset classes that need to be propped up or a combination of these. You should try to be as tax-efficient as possible. Consider making moves inside of a retirement account and using tax-loss harvesting in taxable accounts to the extent possible.
Keep things in perspective
The Fed’s rate hikes are one more factor in what was already a tough year for investors. Higher interest rates combined with inflation and the turmoil from the war in Ukraine have served to facilitate a steep decline in the stock market. Additionally bonds, usually a safe haven, have been hit due to the rise in interest rates.
While the S&P 500
is down just under 23% for the year through June 17, it is still about five times higher than it was when the index bottomed out in March of 2009 in the wake of the financial crisis.
Looking back in history, there have been 26 bear markets for the S&P 500 prior to the current decline going back to 1928 according to Ned Davis Research. This is defined as a decline of 20% or more in the index. The average bear market during this time frame has lasted for 289 days with an average decline in the index of just under 36%.
By contrast, stocks gain an average of 114% during the average bull market for stocks. Bull markets last an average of 991 days.
Since World War II there have been 14 bear markets or one every 5.4 years. What we are seeing currently is not out of line historically and this too shall pass. In the words of Green Bay Packers quarterback Aaron Rodgers to uneasy Packer fans a couple of years ago: Relax.
While there is no guarantee how long this down market will last or how steep the decline will be, this is not the end of the world for your investments. Things may get worse before they get better, the Fed is not done tightening. The best advice in the wake of the Fed’s actions is to stick with your long-term plan but be sure to have a degree of liquidity to weather the short-term pain.