What does the interest rate hike mean for consumers?
Consumers have enjoyed years of record-low interest rates that provided borrowers with low repayment options on everything from cars to homes, but the Federal Reserve’s rate hike in December caused some investors to wonder how the rate increase will affect their financial portfolios.
Additionally, the central bank has indicated more rate hikes could be coming as soon as this year. If these hikes happen, rates would begin to move out of the historically low range they have been in for the past decade.
What does this mean for consumers? How will higher interest rates impact investors and consumers who have become accustomed to a low rate environment?
Consumers who have savings accounts, or who invest in certificates of deposit or money market accounts, will earn more on their cash savings. For people dependent upon investment income from these low-risk options, even a modest increase in the rate of return can make an impact.
“Many older Americans, in particular, draw income from Social Security and from the interest they earn on their retirement savings,” said Clay Nickel, director of investment strategy for Arvest Wealth Management. “As long as inflation stays in check, the possibility of a higher rate environment may be welcome news to these people.
“However, rates are likely to increase more slowly than past interest rate hiking cycles by the Federal Reserve. This means it may still be difficult to achieve longer-term financial goals through bank deposits, many of which still yield less than the inflation rate. Savers may need to look to investing in financial markets to meet longer-run objectives.”
Investors who will likely see the biggest negative effect on their money are those who have longer-dated bond holdings such as 30-year and fixed-rate bonds. Ironically, as rates go higher, the value of existing contracts decreases. While investors may not lose money per se, they will see a decline in the value of their bonds compared to what they could have earned prior to rate adjustments.
“Every portfolio is different and there are several factors to consider,” said Scott Phillips, chief investment officer for Arvest Bank. “In a rising interest rate environment, you want the maturity date of the bond to be short. The longer the maturity term, the more its value will fall.”
Phillips said selling longer-term bonds and reinvesting in shorter-term bonds puts investors in more of an offensive position and can help minimize loss for investors who may be considering selling their bonds. Investors who purchase a bond and hold it until maturity may be able to avoid any depreciation in the bond’s value, depending on where interest rates stand when the bond matures.
Stocks, meanwhile, traditionally gain value during times of rising interest rates.
“Initially, people are fearful that rising interest rates will result in slower economic activity and that it’s not a good idea to invest in the stock market,” said Christopher Magee, senior trust investment officer for Arvest Bank. “Historically, stocks have reacted quite well after a jump in interest rates, but it’s still important for investors to be selective when purchasing stocks, as some sectors will perform better than others.
“Ultimately, every investor is unique with their own goals, timeframes, portfolio mix and risk profile. The important thing for them to know is that after 10 years in an historically low interest rate environment, the Federal Reserve has announced its belief that we will likely see rates slowly moving upward in the next year, so investors need to get with a trusted financial advisor, review their current plan and see what, if any, adjustments they need to make.”