The Federal Reserve recently raised its federal funds benchmark rate by 0.75%. This is the largest increase in more than 30 years and was done as part of its efforts to curb the high inflation that the US is experiencing in 2022. This increase is part of a series of rate hikes that the The Fed had previously announced to help curb inflation.
What are the implications of the Fed’s rate hikes and what should you consider for your own finances?
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High interest debt
Paying off your high-interest credit card and other debts has always been a good financial move, but it’s even more important with the prospect of further interest rate hikes. This is a good time to take steps such as consolidating debt or refinancing that 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 may be a good time to block a fixed rate mortgage. While fixed rate lending rates are higher due to the Fed’s move, we are likely to see a steady rise in adjustable rate mortgage rates.
As the Fed has raised interest rates, we have seen an increase in mortgage rates. This makes buying a home more expensive due to higher payments resulting in a higher mortgage interest rate.
So far, the hot real estate market across the country doesn’t seem to have cooled much. Continued Fed rises could change that and affect both buyers and sellers. Buyers need to decide how much home they think they can afford with current interest rates, and in some cases they may need to reduce the type of home they consider to buy.
Sellers need to consider how their local housing market might react to higher rates over time. Will these higher interest rates reduce housing demand? They should also consider the impact on their plans if this includes buying another property to replace the one they are selling.
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Rebalance your portfolio
The Fed’s interest rate hikes, along with the inflation the Fed is trying to stifle, have largely contributed to the sharp stock market falls we have seen so far in 2022.
It is important to have a long-term investment strategy. A key part of this strategy for most investors is their asset allocation. This is the percentage of your portfolio for equities, bonds and cash. Beyond these main categories, you will likely have an allocation for asset subclasses, such as large and small capitalization stocks, growth and value, national and non-US holdings, as well as one or more varieties of bonds. Ideally, your schedule should include target percentage ranges for each type of investment.
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When the stock market falls, along with the weakness of bonds due to rising interest rates, it is important to review and, if necessary, rebalance your portfolio to its target range by asset class.
The rebalancing should occur throughout your portfolio, including taxable accounts and retirement accounts such as IRAs or a 401 (k). Rebalancing can be done by buying and selling investments, directing new money to asset classes to be supported or a combination of these. You should try to be as tax efficient as possible. Consider moving into a retirement account and using the collection of tax losses on taxable accounts to the extent possible.
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Keep things in perspective
Fed rate hikes are another factor in what has already been a difficult year for investors. Higher interest rates, combined with inflation and the turmoil of the Ukrainian war, have served to ease a sharp drop in the stock market. In addition, bonds, usually a safe haven, have been affected by rising interest rates.
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While the S&P 500 SPX,
it has fallen slightly below 23% during the year to June 17, still about five times higher than it was when the index hit rock bottom in March 2009 as a result of the financial crisis.
Looking back on history, there were 26 bear markets for the S&P 500 before the current fall dating back to 1928, according to Ned Davis Research. This is defined as a decrease of 20% or more in the index. The average bearish market during this time period has lasted 289 days with an average index fall of just under 36%.
In contrast, stocks gained an average of 114% during the average bullish stock market. Bullish 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 currently seeing is not offline historically and this will also happen. In the words of Green Bay Packers quarterback Aaron Rodgers to restless Packer fans a couple of years ago: Relax.
While there is no guarantee of how long this market will last or how hard it will fall, this is not the end of the world for your investments. Things can get worse before they get better, the Fed hasn’t quite hardened. The best advice after Fed action is to stick with your long-term plan, but make sure you have some liquidity to withstand the short-term pain.