The Fed met yesterday and reiterated their intention to raise raise rates this year. So will raising rates be good or bad for your portfolio?
But first…what does raising rates do to the economy?
As Uncle Jerome talked about yesterday, one of the Fed’s two mandates is price stability (aka keeping inflation in check).
When they raise rates, they “cool off” a hot economy.
Remember your Econ 101 class? Inflation occurs when there’s too much demand chasing too few goods.
So raising rates cools demand because it makes it more expensive to buy things.
Housing is an easy example. If mortgage rates are higher… mortgage payments are higher… which will make buyers think twice… which lowers demand……which helps lower inflation.
Okay…so what about my portfolio?
Long-term it’s good.
When an economy gets too hot, bad things happen.
The Housing Crisis of 2008 and the Internet Bubble of 2001 both came on the back of a “too hot economy”.
So raising rates to cool the economy helps prevent drastic pullbacks like those… which reduce portfolio volatility…which gives you a higher absolute return over time.
Short-term it can hurt.
The market tends to react to rate increases like your 5 year-old when you take away her Halloween candy.
The market will kick and scream for a bit and then it’ll pass out after the sugar rush and tantrum wear off.
But the real question is what should we do about it?
And the answer is – we’ve already done it. (If you’re a Financial Zen Member anyways.)
You see the value portions of your portfolio tend to do well in rising rate environments while the growth portions tend to do poorly.
So remember how I was trimming the gains in your growth allocations last year through rebalancing?
Yup. Well trimming those gains is helping you now.
Large-cap growth is down 14.4% this year, while large-cap value is only down 5.0%.
Put a bow on it
So be prepared for a little short-term volatility while the market throws a hissy fit this year over the rate increases.
But just remember, it’s better to deal with a temporarily hysterical 5 year-old than an up-all-night vomiting one.
It will pass and we’ll be better for it.
