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Jon Dulin picked his first stock when he was a teenager. Precocious? Maybe. But he got the idea in an utterly age-appropriate way. As teenagers do, he often hung out at the mall. There he noticed a ubiquitous bright pink shopping bag—the signature carrier for a well-known women’s apparel store. So Dulin, now an adult, invested. He put in $500 and doubled his money in three years.
Although he lost some money on subsequent stock picks, he kept at it, and is now a full-time writer for the personal finance blog Money Smart Guides. Of all the lessons Dulin has learned over the years about saving and money management, one is key: Big or sudden changes to a portfolio or investment philosophy aren’t usually a good move.
This may be applicable whenever the Federal Reserve raises its benchmark interest rate and as you consider how interest rates affect retirement plans.
Higher interest rates have implications for savers everywhere, and you may be wondering: How will rising interest rates affect my retirement? The answer depends on a number of factors, but first and foremost, it may depend on your age and target retirement date.
“I’m just shy of 40 years old, so I have a decent amount of time to go before I retire,” says Dulin, who has not changed his retirement strategy in response to rising rates in the past. “But for people who are older and getting closer to retirement, paying attention to interest rates—whether we’re in a rising interest rate environment or a declining interest rate environment—is important. A lot of times, you’re trying to live off the income that your investments are generating.”
To be sure, it’s a good idea to keep an eye on anything impacting your savings at any age. But whether you’re 25 or 65, it’s important not to react too swiftly or dramatically to interest rate changes. Instead, stay calm, be patient and take the long view, Dulin says.
Following these five guidelines can help you determine what a Fed rate hike means for your retirement and how to stay on track:
As you consider what a Fed rate hike means for your retirement, remember that higher interest rates at the Fed can translate into higher interest rates on savings accounts.
A Fed rate hike may also be a good time to boost your savings overall. The more cash you have stashed away in a savings account as interest rates rise, the more you stand to benefit from more-generous terms at banks. With higher interest rates on savings accounts or other savings vehicles (think certificate of deposit or money market account), you may earn a little more for every dollar. If you’re trying to leverage the way interest rates affect retirement plans, this can go a long way toward meeting your retirement-savings goals.
One way that interest rates affect retirement plans is by prompting savers to re-examine their investment portfolios and asset allocation. A long period of low interest rates can steer many people away from low-yielding bonds, savings accounts and certificates of deposit and toward dividend-paying stocks that offer higher returns, Dulin says.
“When interest rates rise,” according to Dulin, “it probably makes sense to start looking at selling off some of those assets and moving back toward bonds. If you’re too heavily weighted in equities and you’re coming toward retirement—and we have another situation where the market crashes—you’re going to lose a lot more.”
Bonds may start to look more attractive to savers nearing retirement, as bond yields commonly rise when market interest rates increase.
One caveat to remember as you weigh what a Fed rate hike means for your retirement: While newly issued bonds may offer higher yields when rates go up, the value of existing bonds can go down. And the longer the duration of a bond, the more sensitive its price is to market interest rate changes, says Robert R. Johnson, co-author of the book “Invest with the Fed: Maximizing Portfolio Performance by Following Federal Reserve Policy.”
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When asking “how will rising interest rates affect my retirement?” the answer could be in certificates of deposit (CDs). When interest rates go up, you might consider shifting some funds from stocks to CDs, says Andrew Schrage, co-owner of the personal finance blog Money Crashers. But if you do, he recommends choosing short-term instruments. That way, if rates continue to rise you can take advantage of the higher earnings by reinvesting the funds at the end of each term.
CD laddering might be another strategy to consider, Dulin says. For example, you could simultaneously deposit equal amounts into a three-month and a six-month CD. If interest rates continue to rise, as each instrument matures you’ll be able to reinvest the money at higher and higher interest rates.
Interest rates affect retirement plans through their impact on the stock market, too. When an interest rate hike is on the horizon, you may want to tweak your stock portfolio to favor investments in market sectors that perform better when rates are on the way up, Johnson says.
Since rising interest rates can make it more expensive to take out loans and use credit to pay for goods, those rate increases may have an impact on consumer behavior. But experts have differing views as to how consumers react. Some believe discretionary spending may increase during the early part of a rate hike because the Fed raises rates when the economy and consumer confidence are improving.
Johnson, in contrast, believes that discretionary spending tends to go down, which in turn pushes down the value of stocks in market sectors reliant on consumer borrowing, like automobiles, durable goods and apparel. “When rates are rising, you don’t need to buy cars, you don’t need to buy a washing machine, you don’t need to buy that new suit,” says Johnson, who is also president and CEO of The American College of Financial Services, a nonprofit, accredited, degree-granting institution in Bryn Mawr, Pennsylvania.
On the other hand, he says some non-discretionary sectors—such as energy, consumer goods, utilities and food—tend to hold their own in an environment of rising interest rates because consumers need them regardless. “You need to heat your home, you need to buy toothpaste, you need to buy food, whether rates are up, down or sideways,” he says.
Let’s say you’ve determined some answers to the question, “how will rising interest rates affect my retirement?” Should that assessment lead to an overhaul of your entire saving strategy? Probably not.
“I am not a big fan of large changes in overall retirement planning strategies in anticipation of changes in interest rates,” Johnson says. “Interest rates rise and fall, and making wholesale changes is not advisable because it can lead to large portfolio turnover. I believe that the asset allocation—stock and bond mix—should remain largely unchanged.”
Schrage would encourage retirement savers not to let any short-term market volatility scare them away from the stock market.
“There might be a bit of a cause for concern for folks who are closer to retirement age, but especially for younger folks, it’s best to try not to change course because of volatility in the near term,” he says. “That might cause you to make a rash decision, which could cost you over the long run.”
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