5 Money Moves to Make Before the Fed Raises Rates
January 13, 2022
If you’ve been paying attention to financial news lately (and there’s plenty of reasons why you should!), you’ve probably heard that the Federal Reserve is going to raise interest rates. What does that mean for you as an investor?
We’ve put together this quick guide to preparing for the upcoming Fed rate hikes. You might be surprised to find out that bonds may not be the best investment right now…
What Is a Federal Reserve Rate Hike?
OK, so let’s get through the basics first.
The Federal Reserve (often called the Fed) is the central bank of the U.S.
As well as doing stuff like regulating commercial banks, the Fed’s main job is controlling monetary policy by affecting the supply and demand for base money (the money in your wallet).
One of the ways the Fed does this is by setting the fed funds rate.
What Is the Fed Funds Rate?
Very simply put, that’s the interest rate at which banks lend each other money.
This rate affects all other rates — including those you pay on your credit cards and the rates at which your bank pays you for owning a savings account or CD.
When the fed funds rate is very low, it’s considered expansionary monetary policy. Because during this time, people can get car and home loans on the cheap or pay less in credit card interest, they tend to spend this extra money.
Slashing interest rates is a relatively quick and easy way to stimulate the economy.
And that’s what happened in 2020.
Why Did the Fed Lower Interest Rates?
When the COVID pandemic reached the U.S. in spring 2020 — and businesses everywhere shut down — our economy fell into a recession.
The Fed swiftly nipped this in the bud by lowering the fed funds rate to near zero. It was an emergency move to save the economy.
And it worked. The 2020 recession was the shortest in the country’s history:
Why Will the Fed Raise Interest Rates?
But now the economy has rebounded. And prices for everything have skyrocketed, due to supply-and-demand imbalances.
That means inflation is growing at a rate we haven’t seen in nearly 40 years — about 7%.
So the Fed plans to raise the fed funds rate to curb the growth and get the economy back to normal.
Several huge investment banks — such as Goldman Sachs — are expecting the Fed to raise rates three or four times in 2022. And that has implications for investors.
What Do Fed Rate Hikes Mean for Investors?
Unfortunately, higher interest rates can have a negative effect on stocks. That’s because the costs of doing business rises for companies (they have to pay higher interest rates on their debt).
That can eat away at companies’ revenues and earnings and slow their growth rates.
A lot of investors bail on the markets and plan to jump into new higher-interest-rate-paying bonds.
And existing bonds also become cheaper so that investors will want to buy them despite their relatively low interest payouts.
In a nutshell, interest rate hikes can play havoc on the market and lead to a ton of volatility.
So what should an investor do?
What Should Investors Do Before a Rate Hike?
First of all, don’t panic.
Right now — before the new rates take effect — is the best time to get your investing ducks in a row. The best way to do that is with a cool, informed head.
1. Don’t Fall Into the Bond Trap
Don’t be tempted to buy up the low-rate-paying bonds and other longer-term fixed-income assets that are already available. They’re a waste of time. Currently, the 10-year Treasury note is paying a lousy 1.62%. You can do better!
If you want bonds in your portfolio, wait until after the interest rate hikes have occurred.
Owning bonds can help protect your portfolio against padding, but it’s not a good idea to ignore stocks altogether. After all, bonds are very conservative investments, and you’d miss out on the growth that occurs in the stock market.
2. Get Some Dividend-Paying Stocks
Investing in blue-chip stocks that pay dividends is one of the safest moves you can make in the stock market.
These are companies that have histories of making profits — or else they wouldn’t have the dough to pay as dividends!
When you invest in dividend stocks, not only will you profit from any gains in the market, but you’ll also receive regular income payouts.
When looking for a dividend stock, think about the stuff you have on your shelves at home. Coca-Cola (NYSE: KO), Johnson & Johnson (NYSE: JNJ), and 3M (NYSE: MMM) have been great dividend payers for decades.
3. Invest in Financial Companies
This should make sense: Banks love the combination of a strong economy and higher interest rates because they can charge their borrowers more.
Traditionally, bank stocks have performed very well during periods of rate increases. They’re not very exciting, but the money you make from them can be!
Really big, steady banks stand to make some of the best investments right now. We’re talking about the likes of Bank of America (NYSE: BAC) and Citigroup (NYSE: C).
But you can think beyond traditional banks to other financial-related companies like stock brokers and insurance companies, too.
4. Don’t Forget Consumer Discretionary Stocks
With the economy on a roll, people tend to treat themselves to splurges. Historically, this has meant an uptick in appliance, car, clothing, restaurant, and travel stocks.
I’d be tempted to check out car makers like Ford (NYSE: F), which is rolling out tempting new electric vehicles, as well as appliance company Whirlpool (NYSE: WHR).
And if you feel like betting on the eventual return of the travel industry, check out stocks like Expedia (NSDQ: EXPE).
5. Buy Tech at a Discount and Hold On
We mentioned that interest rate hikes can be bad news for high-growth companies. That would include practically everything in the tech sector. Apple (NSDQ: AAPL) might be the exception, thanks to its crazy-great cash flow.
Anyway, if there’s a tech company you really love, now is the time to buy its stock at a discount. Tech stocks have plunged in recent weeks, giving you some great opportunities.
However, be prepared to hold on tight. It’s likely tech stocks will have a wild 2022. If you scoop up any during a price dip, understand that you’ll be holding for the long term.