How to Prepare Your Finances for the Fed’s Next Rate Hike
Life + Money

How to Prepare Your Finances for the Fed’s Next Rate Hike


The markets have been turbulent since the Federal Reserve announced its rate hike in December. That is not your cue to panic.

More than four in ten Americans (41%) told Bankrate they’re concerned about rising interest rates in 2016. Mostly, they're worried about how rising interest rates might affect their personal finances (18%) and what consequences rising rates may have for the economy/stock market (16%). As advisors point out, there is still plenty of time to take necessary precautions.

Related: Growth worries, rate hike uncertainty pull Wall Street down

“The impact of rising interest rates will take some time to show a cumulative effect,” says Greg McBride,’s chief financial analyst. “Now is the time for consumers to insulate themselves from rising rates, such as refinancing from an adjustable-rate to fixed-rate mortgage and snagging 0% balance transfer credit cards.”

Joe Correnti, senior vice president of brokerage product at Scottrade, notes that the Fed’s short-term interest rates serve as a barometer for rates that you might get through a bank checking or savings account or a money market account. That being the case, higher rates can lead to higher borrowing costs for credit card or mortgages tied to the prime rate.

All that said, the Fed's rate hikes will still have a limited impact. Advisors point out that the Fed controls just one set of short-term interest rates: the funds rate, which is the interest rate that banks or similar institutions charge other banks for unsecured short-term loans (typically overnight) to help meet Federal Reserve requirements. We'll note that when interest rates rise, bond prices usually fall. If the Fed goes through a period of raising short-term rates -- as is the plan -- bond prices are likely to fall. You'll still get all of your principal back of you hold your bonds until they mature, but that's about it.

“Trying to predict what the Fed might do, and how the markets will react, can be challenging,” says Correnti. “For long-term investors, it makes sense to have an understanding of interest rates, but it might not make sense to make a lot of changes to a well-diversified portfolio based on where you think rates are headed.”

Related: The Fed’s Dilemma: Is the Economy Slowing or Surging?

Meanwhile, stocks are a bit tougher to gauge by rate activity. What Correnti says is typical, however, is that markets will initially react negatively to rising interest rates -- as we've seen this year. Benjamin Alderson, senior area manager of the U.S. offices of U.K.-based advisory firm deVere Group, says investors should prepare for a very difficult period on financial markets, but should avoid knee jerk reactions.

“The message to investors is diversify as broadly as you can across asset classes, while avoiding higher risk and illiquid assets altogether,” he says. “But avoid panicking.... In fact, stock market falls as new U.S. rate cycles kick in are nothing new and neither are recovery rallies. The last three interestrate cycles all began with several months of losses on the S&P500 and global stock markets, before strong recovery rallies followed.”

That hasn't prevented investors from getting jittery.

According to a survey of wealthy investors by UBS Wealth Management Americas, most investors (77%) expect market volatility to be temporary, while nearly a quarter (23%) think it signifies that the U.S. is on the verge of a longer-term market decline. Those wealthy investors have been holding significant cash reserves (20% on average) for the last several years as a safety precaution.

"Even before recent volatility tested their resolve, investors struggled to weigh the economic recovery and its positive effects on their finances against the lingering emotional fallout from 2008 and 2009," says Paula Polito, client strategy officer for UBS Wealth Management Americas. "The financial crisis appears to have cast a long shadow on investors."

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That shadow isn't clearing, either. Nearly nine out of 10 (89%) investors have maintained or increased their cash holdings since the financial crisis, and approximately 40% believe investors can never hold “too much” cash. Seven years after the financial crisis and the ensuing bull market that followed, only 33% would jump on a market decline as an investment opportunity.

“Indeed, volatility of the kind that 2016 will be shaped by should not necessarily be feared,” says deVere Group chief executive Nigel Green. "Volatility can represent enormous opportunity. When markets fall, it is a chance for investors to start putting new money to work into the market at lower prices.”

That strategy is a bit tougher to embrace when you don't have a cushion for mistakes. Bankrate found that nearly two in three Americans don’t have enough savings to pay for a $500 car repair or a $1,000 emergency room bill. Only 37% of U.S. adults have enough savings to pay for these unexpected expenses, while 23% would reduce their spending on other things to make ends meet, 15% would use credit cards and another 15% would borrow from family or friends.

“More than four in ten Americans either experienced a major unexpected expense over the past 12 months or had an immediate family member who did,” says Sheyna Steiner,’s senior investing analyst. “This proves that an emergency savings cushion is more than just a personal finance cliché, yet most Americans are ill-prepared for life’s inevitable curveballs.”

Related: Why This Isn’t a Typical Bull Market Pullback

In a way, though, that's only made U.S. investors more prepared for Fed rate hikes, global instability or even personal emergencies.

Increasingly, investors are beginning to see all of those factors as variables in their financial plan. According to a survey by Hartford Funds, roughly 30% of investors expect global instability to have the greatest impact on their finances in 2016, compared to less than half that number (14%) who expect interest rates to be the biggest factor. Throw all of the above int with stock market volatility (25%), economic growth (18%) and the presidential election (13%), and investors already have plenty of motivation to diversify their holdings and shield themselves from financial shocks.

That doesn't even include the 39% who expect a major life event to affect their finances this year. Whether it's the nearly 20% of Americans who expect to be dealing with an aging parent in 2016, or the 18% of folks under the age of 45 expect a parent or child to move into their home, investors are starting to expect the unexpected. Perhaps that's why 53% investors don’t expect major personal events to impact their finances in 2016 -- and why the rest of us should calm down about rate hikes.

“Investors’ confidence should be tied directly to tracking against their goals and having a strong understanding of how life can throw financial curveballs,” says John Diehl, senior vice president of strategic markets at Hartford Funds. “Taking a more human-centric approach to investing helps advisors and investors see the big picture when it comes to life and finances.”

This article originally appeared on Main Street. Read more from Main Street:

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