WASHINGTON — Janet Yellen, the head of the Federal Reserve, has been preparing us for a hike in the Fed funds rate likely to occur sometime mid-year. So what does this mean for you and your money? It depends whether you’re saving, borrowing or investing.
Savers: Not much to cheer about.
The proposed Fed interest rate hike going from 0 percent to 0.25 percent probably won’t make any difference to the interest offered by banks on money market accounts and Certificates of Deposit (CDs). It’s unlikely that you will be rewarded with higher interest rates on your short-term savings.
Borrowers: Make your move sooner rather than later.
If you’re borrowing money to buy a home, don’t be surprised to see mortgage rates climb higher this year.
The Home Buying Institute asked three expert sources for their mortgage rate predictions. Freddie Mac and the Mortgage Bankers Association expect the average rate for a 30-year fixed mortgage to reach 5 percent by the end of 2015. Lawrence Yun, chief economist for the National Association of Realtors goes as high as 5.5 percent in 2015.
Now’s the time to refinance your mortgage, if you haven’t already, as interest rates may not be this attractive again.
Investors: Four adjustments to consider.
There are four things I recommend investors consider to prepare their portfolios for rising interest rates:
1: Evaluate your bond holdings: Those “safe” investment grade bond funds and bond ETFs are likely more dangerous than you may think. Why? There is potential for a big drop in the prices of these bonds due to their sensitivity to rising interest rates and it’s greater than it’s been in years.
A 1 percent move up in interest rates could cost you 5 percent in your bond fund. The problem is that the paltry 2 percent or so yield in these bond portfolios is about as low as it’s ever been while at the same time bond maturities in the bond index are as long as they have ever been at 7.2 years.
This means more risk and less protection if rates rise dramatically. Investors may want to consider replacing bond funds, which have interest rate risk for those with credit risk. Keep in mind that while this may reduce your exposure to the effects of rising interest rates, the downside is that you may experience more volatility and more correlation to stocks.
Recommended reading: The Best Way to Invest in Bonds in a Rising Interest Rate Environment
2: Reduce exposure to interest-sensitive equities: Consider reducing your exposure to U.S. REITs (real estate investment trusts), utility stocks and high dividend-paying equities, as these are sensitive to rising interest rates. While they have enjoyed several years of great performance as interest rates fell broadly, that party may be ending soon.
3: Consider reallocating to small company and foreign stocks : With the run up in U.S. large company stocks, your portfolio likely has too much exposure there and too little exposure to small company and foreign stocks, especially if you haven’t rebalanced your portfolio recently. It may be time to consider reallocating some of your U.S. equity exposure.
One reason is that small companies do most of their business in the U.S. in dollars so they don’t face the same currency headwinds that have negatively impacted large U.S. multi-national companies (Intel, IBM, McDonalds, FedEx, etc.). Foreign stocks have been out of favor with investors because of the fear of the rising US dollar. This has generally made them less expensive than stocks in the US, making them a better bargain.
Recommended reading: A Review of the Worst Investing Strategies
4: Hold some cash for future reinvestment: While cash doesn’t currently pay much, and may not even when the Fed begins to raise short-term rates, it’s still a good idea to keep some cash available for investment when yields do go higher.
Regardless of whether you’re a saver, borrower or investor, by preparing now, you won’t be caught off guard when interest rates rise.
