By Jeff Bogart
Learn more about Jeff on NerdWallet’s Ask an Advisor
Since the Great Recession started eight years ago, the Federal Reserve has kept its benchmark interest rate near zero as a way to strengthen the economy. However, according to the minutes from an October 2015 gathering of Fed officials, a rate increase is likely in December. A decision should be announced Dec. 16.
Any economic change brings good news and bad news. Here are a few parts of your financial life that might be affected by a rate increase:
Rising interest rates generally put downward pressure on the demand for homes and home prices, at least in the short term. So if the Fed raises rates, you may not see very many “For Sale” signs in front yards for a while.
This might make you nervous if you’re planning to sell your home soon. After all, most people’s wealth is in their homes. But a small rate increase doesn’t necessarily mean that the housing market will plummet. If rates stay near their historic lows, many prospective buyers will realize that they still can afford a new home and will buy one, anyway.
Interest rates and bond prices move in opposite directions. When interest rates go up, bond prices go down. If you’re thinking about selling your bonds before they mature, higher interest rates will work against you. However, if you’re holding those bonds until maturity, you can sleep well. You’ll still collect interest, though at a lower rate than you would on newer-issue bonds.
If you own shares of a bond mutual fund, a rate increase will more than likely cause those shares to temporarily drop in value. But fund managers will begin to buy higher yielding bonds, which might help soften the blow. For the future, consider this strategy used by proactive bond fund investors: Stay out of long-term bond funds, which take the biggest beating when rates rise.
The effect of rising interest rates on stock prices is a little murkier than its effect on bonds. Stock prices generally decrease when interest rates go up, but that’s not always the case. If we’re in an economic expansion when rates rise, more often than not, stocks go up. Conversely if the Fed is raising rates to “cool down” an overheated economy, stocks tend to go down before rebounding. If you own CDs, their rates will increase immediately if the Fed raises the benchmark.
Hiring and income
By keeping rates low, the Fed hoped to encourage economic growth, which is often measured by employment numbers. If the Fed does raise rates, it would be a signal that employment is recovering, and firms are hiring.
More hiring means more income for everybody. And higher incomes tend to solve other problems, including low demand for housing. Even though a rate hike would mean that it costs more to borrow money, higher incomes help offset these costs.
Higher incomes also mean more spending. More spending means that workers keep their jobs. And the cheap prices that we’re seeing at the gas pump put even more money into consumers’ pockets that they’ll want to spend.
In the Fed’s words, it might be time for a rate increase because there’s been a “tightening of the labor market.” In plain English, that means more hiring and less firing. Ultimately, the Fed’s decision reflects growth — which means that, for you, the good news of a rate increase should hopefully outweigh the bad news.
Image via iStock.