|Dec 23 2015||
Federal Reserve Increasing Rates and 401(k) impact
By: Rob Lynn
The Federal Reserve announced on Dec. 16 that it is raising its benchmark interest rates by quarter of a percentage point after ten years of keeping the rate at zero. If the economy continues with its’ moderate paced growth, then the Fed will increase interest rates in the coming quarters. For 401(k) participants, an increasing rate environment will bring both positives and negatives. Rate increases will provide higher returns for savings accounts, which is welcomed news for those who rely on interest income to cover their living expenses. Increasing rates will also be beneficial for those 401(k) participants who are more risk averse because they are moving closer to retirement age.
Higher interest rates can make the bond & stock market more volatile and less predictable. While our economy is “recovering” it is still a somewhat fragile recovery as there are many headwinds such as; low labor participation rates, lack of wage growth, housing starts, manufacturing index, Europe & China economic stagnation. The Federal Reserve’s efforts to return rates to “normal” should be a positive sign of future economic growth. However, increasing rates will also increase individual/commercial borrowing rates and that concern alone can cause stocks to decline in this somewhat fragile recovery. Rate increases will impact long-term bond funds as their underlying value of existing bonds fall as new bonds are issued with higher rates. Over time, higher interest rate payments are reinvested should help level out the bond fund’s return, but volatility in this somewhat stable value investment will increase. 401(k) participants who are strongly risk adverse may want to consider short-term bond funds, stable value funds or money market funds. Most all 401(k) participants are long-term investors who should remain focused more on their investment strategy vs. the short-term fluctuation in the stock or bond prices.
Finally, another impact from the raising rate environment will be the 401(k) borrowing costs. The interest cost of borrowing from a 401(k) will depend on the pricing mechanism established in the participant’s plan document.
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