After hovering at levels near zero since the Great Recession, interest rates are on the rise. The Federal Reserve has now raised the benchmark rate five times since December 2015, including three times in 2017. Although the Federal Reserve chose not to raise rates at its most recent meeting in late January, up to four more hikes are forecast for 2018.
Rate hikes often generate headlines and can cause movement in the market. But how should the average investor with a retirement plan interpret and ultimately react to these shifts in monetary policy?
Here are two things to keep in mind:
Hikes are a good sign
Interest rate hikes are generally an indication that the economy is moving in the right direction. The Federal Reserve lowered the rate about a decade ago in response to the economic crisis. Lower interest rates help boost the economy during periods of difficulty by making it more attractive for consumers to borrow and spend. A low interest rate environment doesn’t offer much for savers, but it’s a core tool in helping to spur economic growth.
We are now seeing the Federal Reserve continue the slow climb up following that seven-year stretch of near-zero rates. This signifies that the Central Bank is optimistic about the current state and direction of the economy and markets. The Federal Reserve takes many different factors into account when making the decision to raise rates, one of the most critical factors being the employment situation. We are coming off a year that saw two million-plus jobs created. Further, the Federal Reserve regularly underscored strong job growth and low unemployment when providing reasoning for recent rate hikes.
While the recent upward move in interest rates is considered a positive and has fostered optimism amongst most investors, it’s important to avoid kneejerk reactions to these shifts in monetary policy.
Regardless of whether you are a seasoned or casual investor, each financial situation is unique and each investor has individualized long-term goals. Avoiding the temptation to significantly alter your portfolio based on economic headlines is important to preserving those goals. Just like when the Dow crosses a new threshold or when geopolitical events create volatility, staying the course is key.
As a consumer, tempering reactions is just as important. The Federal Reserve raises rates methodically in order to give the economy, markets and consumers adequate time to adjust. You may want to consider locking in a rate if you are in the market for a mortgage, but there is no need to make rash borrowing decisions (such as immediately taking out a car loan) in an effort to beat future rate hikes.
Keep in mind that the benchmark interest rate currently sits at a level between 1.25 and 1.50 percent, which is exceptionally low compared to historical levels. It’s a better environment for savers and borrowing is gradually becoming more expensive, but even three more quarter-point hikes this calendar year would only result in an interest rate of around 2 percent. Generally speaking, the overall impact on the average consumer will slowly become more noticeable as rates move higher over the years.
While it’s certainly all right to adapt and make strategic adjustments to your long-term portfolio and borrowing strategies in response to changes in the interest rate environment, staying even keeled and avoiding too large of an immediate reaction can help keep you on the right track financially.