What Rising Rates Mean For You | AWM Insights #129

Rising interest rates have dominated headlines for the last few months, but which rate is the most important to you? Should you be concerned? 

 

The rate you’ve likely heard the most about is the Fed Funds rate. In short, this is the interest rate that banks charge each other if they need to borrow or lend in excess of their reserves. This rate is set by the Federal Reserve and is the main policy tool used to influence other short-term rates in an effort to cool inflation. 

 

Contrary to what you might hear, rising rates does not always mean the stock market will crash or even go down. Past evidence has shown no strong correlation and trying to time the market using this data would be a fool’s errand. Staying the course with your long-term strategy and trusting in your established protective reserve should give you confidence during these times.

 

In this episode of AWM Insights, Brandon and Justin discuss these rising rates, their potential impact on you, and how to navigate market downturns.

 

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EPISODE HIGHLIGHTS:

(0:35) Interest rate talk is dominating headlines. What does that mean for you?(1:29) When you hear about interest rates rising, it's important to ask which interest rate you are talking about. Usually, people are talking about the Fed Funds rate.(1:50) There are so many different interest rates, and each has its own length or term of borrowing.(2:17) When the Federal Reserve increases the Fed Funds rate that directly impacts the short end of interest rates. You can see it in 3-month and 1-year rates pretty easily.(2:50) The longer-term rates tend to do the opposite of what you would expect when Fed Funds rate is rising. They tend to go down. (3:25) When thinking about rates, they don’t necessarily impact long-term rates like a 30-year mortgage. There are many other factors that go into that.(4:11) Short-term rate changes impact variable rates like credit card debt.(4:35) What is the effect on stock market returns when rates are going up? Is it bad for stocks?(5:30) There is no discernible relationship when interest rates are going up or down on equity returns. It is not that easy to say any time rates are going up the market will be going down.(6:00) Cost of capital is a finance term that if a company wants to borrow money and interest rates are higher, then I will have to pay more money for that debt. That has a material impact on profits. (6:29) Cost of capital could be a driver of declines but markets are so incredibly complex that there is no simple explanation. (7:27) Playing a game of letting fed funds rate dictate how you invest isn’t going to work as a strategy. Every other sophisticated market participant already is anticipating future rate hikes. (8:19) Even if you had a crystal ball and knew rates were going up, its impossible to know what the market is priced into the market and what isn’t. (9:00) We’re not saying you shouldn’t be concerned about rising interest rates impacting your situation. High inflation does eat away at future earnings and purchasing power of your money. What we’re saying is to tune out the noise of changing your investment strategy because of interest rate moves. (9:54) A solid financial structure is built ahead of time to hedge the impact during stressful periods like equity and fixed income markets are going through. (10:40) Markets are in bear market territory. The last decade has been phenomenal for returns to investors. It's easy to focus on this single 9-month period and ignore the big picture.(11:45) It is healthy for the market to be pricing in interest rates and future expectations. With higher rates, expected returns for equities in the future are higher.   (12:10) A protective reserve in your portfolio should be constructed to deal with times of adversity. Build-in protection for unexpected inflation is a must.(12:38) The key takeaway is to control what you can control. Marry your resources with your priorities so you know you can weather storms and make it through periods of difficulty. Taking comfort in knowing markets are working and you will be rewarded if you stay disciplined and stick to your plan (13:25) If people are saying they can predict what will happen, it may feel good, but they don’t know the future. Things get a lot more certain over long periods of time.