Fed Rate Hike

“But about that day and hour no one knows…Be on guard! Be alert! You do not know when that time will come.” Mark 13:32-33

The above quote from the Bible certainly has nothing to do with the prospect of the Federal Reserve raising rates for the first time since 2006, but it was the first thing that popped into my head when I decided to write this market commentary. There has been constant chatter, for years now, about the Fed’s stance on interest rates. Will they or won’t they raise rates soon? If soon, will it happen in June, September, or next year? The bottom line is that no one knows, and yet (like the above verse says) we must be on guard for that time.

So how can we be on guard? One of the important things in managing investments is stress testing portfolios for black swan (unexpected) events. The best way to prepare for events is to stay diversified and keep an appropriate level of risk in the portfolio; this level of risk is different for everyone. My job is to 1) ensure that my clients understand their own risk tolerance and 2) invest to that level of risk.

A rise in interest rates isn’t a black swan event, because it IS going to happen at some point; the thing is, we don’t know when it will happen so, while it isn’t improbable, it is unpredictable. When it occurs, it will have a negative effect on the stock market for a short time because, in part, the cost of doing business, namely borrowing money, would go up. It will also have a negative effect on bond holdings as there will be more attractive (i.e., higher rate) bonds available which will drive prices down the prices of existing bonds in your portfolio. For a while now, I have been laddering bonds from 2-10 years in order to capitalize on this, whenever it occurs, so that maturing bonds could be reinvested at the higher rate.

I have talked to several individual investors over the last few years who, at first, didn’t reinvest their maturing bonds at all as they felt that rates were too low and they thought that a rate hike was imminent. By doing this, they traded a possible 1-2% rate for a certain 0% rate. Then, out of desperation for ‘higher’ rates, many have overextended the maturities and bought 20-30 year bonds. This was also a bad decision as they are locked in for a long time at what will eventually be considered a low rate; the interest rate risk just isn’t enough to justify the small increase in return for that long of a period of time.

The bottom line is that we don’t know when a rate hike will occur, so rather than trying to time things, it’s best to stay with your long term investment objective, which coincides with your own risk tolerance, and stay diversified among asset classes and sectors; in so doing, you will be better off than everyone else who thinks they know what the Fed itself doesn’t even know!

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