When interest rates rise: What you need to know
When you hear that interest rates are going up, you probably immediately think about your mortgage or credit card payments. It makes sense: A rate increase could impact your monthly payments. It can also, at least in the short term, make investment markets somewhat volatile—which may leave you with questions about your retirement account.
Having concerns is completely normal. But market changes are nothing new. Get a better understanding of how they might impact returns, and what you might do to keep your retirement saving goals on track.
What are interest rates, and why do they change?
In simple terms, an interest rate is the price of money. For example, the interest you pay on your mortgage is the price you pay your lender to use their money for the length of your mortgage (e.g., 30 years).
The general level of interest rates in the U.S. is decided by the Federal Reserve (our central bank). The Federal Reserve uses interest rates to help guide employment growth and stabilize the economy.
For example, if the economy is growing slowly, they may lower interest rates to encourage increased spending and investing. On the other hand, if the economy is growing too quickly and could cause inflation to rise, they might raise rates to cool it down.
What’s happened in the past when rates have risen?
Markets are typically more volatile while they absorb the rate increase news. How volatile depends on the size and frequency of the rate increases.
Keep in mind—the Federal Reserve has consistently stated that any increase in rates will be “gradual” and overall rates will still remain relatively low.
How the change in interest rates might affect your retirement account generally depends on the investments you hold. As interest rates go up, bond prices typically go down. And historically, stock prices tend to fluctuate following interest rate changes.1
However, a retirement plan is generally designed to help meet your long-term retirement and investment goals. So, while changing interest rates may cause volatility in the short-term, the long-term effect on markets has been positive.2
What can I do?
As you review your investment strategy, keep these things in mind as interest rates change:
- Timing the market. No one can perfectly predict the market, so timing the market may be unsuccessful and impact your long-term objectives. Moving your savings to less risky investments or taking money out of the market during volatile periods may cause you to miss out on any gains if the value of those investments bounces back.
- Staying the course. It’s important to remain focused on your long-term objective, so you don’t make any snap decisions. Choose investments with an acceptable level of risk (based on your preferences and life stage) that reflect your retirement goals.
When interest rates change, it can be a lot to take in. Constant chatter in the news about markets can often be more distracting than helpful. Eliminate the noise and go back to basics—remember why you carefully chose the investments you did, and take the retirement saving path that’s right for you.
1 S&P 500 historical returns compared to the Federal Fund Rate http://www.marketwatch.com/story/what-do-higher-interest-rates-mean-for-stocks-2015-12-17
2 S&P 500 annual returns as of December 31, 2006 to 2015. https://ycharts.com/indicators/sandp_500_total_return_annual
Investing involves risk, including possible loss of principal.
Asset allocation and diversification do not ensure a profit or protect against a loss.
Equity investment options involve greater risk, including heightened volatility, than fixed-income investment options.
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