What do Rising Interest Rates Mean?
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The Wall Street Journal is one of my favorite publications and source of inspiration. On Thursday, Jon Hilsenrath and Victoria McGrane wrote, “Fed Split Over How Long to Keep Cash Spigot Open”, throwing doubt on Federal Reserve chairman Bernanke’s indication that rates would stay low into 2015. The article stated:
“Of late, the view in financial markets has been unsettling: Banks and investors are holding riskier debt. Companies are issuing record amounts of junk bonds.”
These riskier investments are causing the Fed to take notice. Stock market movements are random in the short term and asset prices jump around based on psychology and news (among other things). The possibility that interest rates may increase caused a drop in the stock market.
When the possibility of rising interest rates was mentioned, investors got scared.
Why Did the Stock Market Decline at the Suggestion of Higher Interest Rates?
Investors love low interest rates because:
1. Companies can borrow cash and expand when borrowing costs are low.
2. Theoretically, consumers will borrow, buy more, and stimulate economic growth, when rates are low.
3. Stocks frequently advance when interest rates are low.
If interest rates go up sooner than promised, it will cost more to borrow money for individuals and companies. This may lead to a slowing of economic growth. Unemployment may remain at this relatively high level.
Investors are a nervous bunch and are not always rational. When markets are increasing , investors dive in to participate in the upswing. Due to the behavioral bias of conservatism, they sometimes jump in after waiting awhile thereby missing the biggest upswing and end up “buying high”.
Market Movements are Random
With random market movements, it’s perilous to jump in and out of the markets. Interest rates will rise, that is certain. When… is another matter. If you attempt to tweak your investments based upon market movements, you’re forced to be a forecaster. You have to be right twice, when you buy and when you sell. Interest rates may rise in 2015, or they may rise sooner. Timing your investing based on interest movements is difficult if not impossible. As most of the investment research suggests, the investor is better off setting an asset allocation, in line with one’s age and risk tolerance, and sticking with it. Rebalance annually, and you’re likely to outperform 60-70 percent of active fund managers. And the 30 percent of active fund managers who outperform one year, are unlikely to repeat that outperformance the next.
Don’t worry about when interest rates will rise. Stay invested through thick and thin. There will certainly be peaks and valleys in interest rates as well as asset values; predicting them is very difficult. Whether interest rates are high or low, there are opportunities to profit.
Barb Across the Web
Carnival of Financial Planning at Life Insurancey By Jeff
Carnival of Financial Camaraderie at The Savvy Scot
Yakezie Carnival at Abstract Aucklander
Carnival of MoneyPros at Money Reasons
Carnival of Retirement at My Personal Finance Journey
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When do you think interest rates will rise? Do you adjust your investments based upon market forecasts?
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