The economy changes rapidly, and Federal Reserve interest rates have a direct impact on the U.S. economy as it stimulates economic growth, balances inflation, and maintains a healthy labor market. Lately, it seems all eyes are on the Federal Reserve as they respond to current economic conditions.
If you’re already planning for retirement or nearing retirement age, it’s important to know how changes in economic policy affect you.
More Change Could Be on the Horizon
In late July, The Federal Reserve did something they haven’t done in over a decade - they cut interest rates. Federal Reserve chairman Jerome Powell hinted at the change (a cut of .25%) in his testimony before a House Financial Services committee, citing some “uncertainties about the outlook” of US economic conditions as motivating factors:
- Economic momentum appears to have slowed in some major foreign economies
- Unresolved government policy issues including trade developments, the federal debt ceiling, and Brexit
- Weak inflation (below the government’s 2% objective)
The POTUS has been vocal about demanding lower interest rates and complained that the recent quarter-of-a-point cut was not enough. Likewise, experts predict more cuts may be coming.
How Do Federal Interest Rates Impact the Stock Market
At Wealth Legacy Institute, we are commonly asked – how do interest rates (the rates at which banks borrow money from each other) affect the stock market? Generally, when the Fed cuts interest rates, the stock market rises and when they raise interest rates, the stock market overall goes down. But this inverse relationship is not set in stone.
The psychology behind a federal interest rate cut is that lower rates spur consumers and businesses to spend and invest more. As a result, the economy is invigorated and stock prices rise. In the event of a hike in the rate, people and businesses would cut back, and stock prices would fall.
However, the fed’s actions don’t always match up exactly with public expectations. If the Fed announces a cut of a quarter of a point less than expected, for example, stocks could still decline. People react based on their assumptions, so the extra .25% cut would have already been “priced in” to the market.
The overall state of the economy can also affect the market's reaction. In a weakening economy, the boost provided by lower rates may not be enough to stimulate significant economic activity, and stocks stay low. In a boom cycle, on the other hand, certain sectors will continue to prosper in the face of raised rates - such as tech stocks, growth investments, and entertainment companies.
In summary, there’s no guaranteeing how the market will react to a given interest rate change enacted by the Fed.
What Does This Mean for Your Retirement Plan?
If you’re currently planning or saving for retirement, you’re probably wondering – how do interest rate cuts affect me?
Economic changes outside of your control can be scary and frustrating. But changes or even tumultuous times do not have to mean a major overhaul of your personal retirement plan. The best retirement plan is one that can withstand changes in the stock market (and your life).
When the stock market goes down, many 401k owners get a shock when they look at their account. But there’s no need to panic. Remember that a retirement investment plan is a marathon, not a sprint, and a diversified mix of stocks, bonds, and cash reduces risks and helps minimize losses over the long term.
It’s also possible that if you planned to buy a new home in retirement, changing interest rates could increase or decrease the purchase of a new mortgage. A trustworthy financial advisor can advise you during these economic and life changes.
Work with a financial advisor who has their finger on the pulse, understands the industry trends and is working for you. Wealth advisors who aren't fiduciaries might seize short-sighted stock or investment opportunities that could burn you in the long-run. But a fiduciary working in your best interest will see the bigger picture, helping you create and stick to a solid plan for the future.
If you’re looking for retirement and financial planning tips from a financial advisor you can trust, check out Money Secrets.