Before we start looking at what you can do to traverse the challenging waters of inflation and interest rates, let’s make sure we’re all speaking the same language.
Interest refers to the cost of borrowing or the return on savings. Sounds simple, right? But this rudimentary concept can have extraordinary impacts on our economy.
Interest rates are impacted by inflation and the Federal Reserve’s subsequent monetary policy. I like to use the analogy of bathwater. You want to have the temperature just right. When inflation is high, the central bank turns on the cool water to increase interest rates, making money more expensive to borrow, which can reduce consumer spending and “cool” the economic waters. On the other hand, when inflation is low, the central bank turns on the hot water by decreasing interest rates to accelerate borrowing and consumer spending. As a result, the economic waters heat up.
Sign up for Kiplinger’s Free E-Newsletters
Profit and prosper with the best of expert advice on investing, taxes, retirement, personal finance and more - straight to your e-mail.
Profit and prosper with the best of expert advice - straight to your e-mail.
When interest rates are high, investors want greater returns from their investments to compensate for the loss of purchasing power caused by inflation. When inflation is low, investors may accept lower returns, meaning lower interest rates.
How interest rates and inflation affect the markets
We also see impacts in the stock market. When interest rates are high, some investors depart their stock component in their investment strategies to seek fixed rates on savings vehicles like CDs, fixed annuities or bonds. When enough investors do this, we see a decline in the stock market. When interest rates decline, investors start searching for ways to grow their money, and some may revisit their stock strategy.
Many of my client conversations revolve around this topic. Last year, one of my clients was considering exiting the diversified mutual fund strategy we established to transition to a more conservative strategy. We revisited their “why.” Why are they adding to their mutual fund portfolios? Their answer is they want to make sure they have enough assets to supplement their retirement in eight years.
Their time horizon, or how much time they have to save for their retirement goal, is a valuable piece of information because it helps determine their investment allocation, or how their accounts are invested. After our review, we found it is appropriate for their goal and ultimately decided against the more conservative strategy.
Focusing on the 'why' rather than on emotions
A lot of my clients ask me how to navigate the uncertainty of the interest rate landscape, since we don’t know how the Fed will adjust rates. I ask them to look at their “why” when it comes to their ongoing contributions to retirement accounts, or how they are going to use an investment account. We revisit our goals and time horizons and ask ourselves whether our plan needs a change vs our emotions telling us it needs a change. When we experience negative returns, our emotions tell us to minimize our losses and get out. When the market is doing well, we want to get in and not miss out.
If your investment strategy is to liquidate when the market is down and return when the market is high, that is a recipe for failure. A disciplined investor will revisit their “why” and the path they are traveling to reach that financial goal. That evaluation usually uncovers the opportunity to add more to their investment account when the market is down.
High interest and inflation rates are nothing new — this has happened in the past, and investors got through it. We will, too.
Case studies may not be representative of the results of all clients and are not indicative of future performance or success.
The opinions expressed are those of the author and do not necessarily represent those of the employing firm. Case studies may not be representative of the results of all clients and are not indicative of future performance or success. FM-6001461.1-1023-1125
Related Content
-
Stock Market Today: Dow Slides 697 Points on Super-Hot Jobs DataWhen the December nonfarm payrolls report hit the tape, there was no question which way stocks would go at Friday's opening bell.
-
Essential Tech Tools for Managing Your Home and Finances While TravelingStay secure and stress-free on the go with the best tech tools for managing your home, bills and security from anywhere.
-
The Wrong Money Question to Ask After Trump's ElectionIf you're wondering what moves to make with a new president moving into the White House, you're being dangerously shortsighted. Here's what to do instead.
-
An Investing Plan for This Year: Doing Less Can Lead to MoreAchieve more when investing in 2025 by planning to work smarter, not harder. These three strategies can help put you on the right track and keep you there.
-
All About Six Types of Auto Insurance CoverageDo you know what your auto insurance policy covers? Here's a primer on some coverage categories, along with examples of how each type of coverage works.
-
Social Security and Medicare Funding: Is the Sky Falling?Social Security and Medicare are slowly running out of money, but what does that mean for the retirees counting on them? Actually, it's not all bad news.
-
What We Need to Do to Protect Retirees' Financial SecurityCognitive decline and aging in general put older retirees at risk of losing their financial security when they're the most vulnerable. What can be done?
-
Financial Planning: Sisters Should Be Doin' It for ThemselvesMore and more women are ringin' on their own financial bells (with apologies to Aretha Franklin and Eurythmics) — but that demands a robust financial plan.
-
Is Money Messing Up Your Family's Life?Parents who discuss money and attitudes toward money with their children are more likely to raise financially successful and responsible adults.
-
Do You Know the Power of Whole Life Insurance in Retirement?Worried about legacy planning, market volatility or where to get cash to cover surprise medical or home repair bills? This little-known tool could help.
