What Rising Rates Could Mean for Your Money

After years of keeping the benchmark federal funds rate at historic lows, the Federal Reserve has been raising it gradually. Near-zero rates were an emergency measure, and gradual increases reflect greater confidence in the U.S. economy. However, rising rates can affect you as a consumer and investor.

What is the federal funds rate?

The federal funds rate is the interest rate at which banks lend funds to each other overnight to maintain legally required reserves. It applies only to funds that stay on deposit within the Federal Reserve System. The Federal Open Market Committee (FOMC) sets a target range for the funds rate, usually a 0.25% spread, and then sets two specific rates that act as a floor and a ceiling to push the funds rate into that target range. The rate may vary slightly from day to day, but it generally stays within the target range.

Although the federal funds rate is an internal rate within the Federal Reserve System, it serves as a benchmark for many short-term rates set by banks and can influence longer-term rates as well.

Why does the Fed adjust the federal funds rate?

The Federal Reserve and the FOMC operate under a dual mandate to conduct monetary policies that foster maximum employment and price stability. Adjusting the federal funds rate is one way the central bank can influence economic growth and inflation.

In December 2008, the heart of the recession, the FOMC dropped the federal funds rate to a 0.00% to 0.25% range in an effort to stimulate the economy and generate job growth. Because the economic recovery was slow and inflation remained low, the rate remained at this historic low until December 2015, when the FOMC raised the target range by 0.25%. The next 0.25% increase came in December 2016, followed by further increases in 2017.

The FOMC raises the federal funds rate in an effort to slow the economy and hold back inflation, which can rise rapidly when an economy grows too quickly. The Fed has set a 2% annual inflation goal as consistent with healthy economic growth. The FOMC began to raise the funds rate while inflation was still under 2% because it believed that the employment situation was strong enough to begin the transition from emergency measures toward a more "normal" interest rate environment. Since then, inflation has moved closer to the Fed's target, and raising the federal funds rate helps to guard against inflation rising too quickly in the future.

How will consumer interest rates be affected?

The prime rate, which commercial banks charge their best customers, is typically tied directly to the federal funds rate. Though actual rates can vary widely, small-business loans, adjustable rate mortgages, home equity lines of credit, auto loans, credit cards, and other forms of consumer credit are often linked to the prime rate, so the rates on these types of loans typically increase with the federal funds rate. Fed rate hikes might also put upward pressure on interest rates for new fixed rate home mortgages, but these rates are not tied directly to the federal funds rate or the prime rate.

Although rising interest rates make it more expensive for consumers and businesses to borrow, retirees and others who seek income could eventually benefit from higher yields on savings accounts and CDs. However, banks have been faster to raise rates charged on loans than to raise rates paid on deposits. This may change as rates continue to rise and the economy continues to improve. Theoretically, the "tipping point" for savers will come when banks have to compete for deposits in order to meet higher demand for loans.

What about investors?

Interest rate changes can have broad effects on investments, but the impact tends to be more pronounced in the short term as markets adjust to the new level.

When interest rates rise, the value of existing bonds typically falls. Put simply, investors would prefer a newer bond paying a higher interest rate than an existing bond paying a lower rate. Longer-term bonds tend to fluctuate more than those with shorter maturities because investors may be reluctant to tie up their money for an extended period if they anticipate higher yields in the future.

Bonds redeemed prior to maturity may be worth more or less than their original value, but when a bond is held to maturity, the bond owner would receive the face value and interest, unless the issuer defaults. Thus, rising interest rates should not affect the return on a bond you hold to maturity, but may affect the price of a bond you want to sell on the secondary market before it reaches maturity.

Bond funds are subject to the same inflation, interest rate, and credit risks associated with their underlying bonds. Thus, falling bond prices due to rising rates can adversely affect a bond fund's performance. However, as underlying bonds mature and are replaced by higher-yielding bonds within a rising interest rate environment, the fund's yield and/or share value could potentially increase over the long term.

Equities may also be affected by rising rates, though not as directly as bonds. Stock prices are closely tied to earnings growth, so many corporations stand to benefit from a more robust economy. On the other hand, companies that rely on heavy borrowing will likely face higher costs going forward, which could affect their bottom lines.

The broader market may react when the Fed announces a decision to raise rates or not to raise rates, but any reaction is typically temporary. Fundamentally, what matters is how the economy performs as interest rates adjust. As always, it's important to maintain a long-term perspective and make sound investment decisions based on your own financial goals, time horizon, and risk tolerance. The FDIC insures CDs and bank savings accounts, which generally provide a fixed rate of return, up to $250,000 per depositor, per insured institution. The return and principal value of stocks and investment funds fluctuate with market conditions. Shares, when sold, may be worth more or less than their original cost.

 

 

Disclaimer: This commentary is provided for educational purposes only. The information, analysis and opinions expressed herein reflect our judgment as of the date of writing and are subject to change at any time without notice. They are not intended to constitute legal, tax, securities or investment advice or a recommended course of action in any given situation. All investments carry a certain risk and there is no assurance that an investment will provide positive performance over any period of time. Information obtained from third party resources are believed to be reliable but not guaranteed. Past performance is not indicative of future results.

Investment Advisory Services offered through Asset Strategy Advisors, LLC (ASA), a SEC Registered Investment Advisor. Securities offered through Triad Advisors, LLC, a broker-dealer, Member FINRA/SIPC. Insurance offered through Charles River Financial Ins Agcy (CRFG). ASA, CRFG and Triad are separate companies.

Federal Reserve Raises Rates

The federal reserve raised interest rates yesterday by one quarter point. This move was widely expected by the markets which explains the subdued market reaction in both the fixed income markets and stock markets following the announcement. They did however make note that they are aware and will monitor the recent inflation data which has come in softer than expected.  

Most fed members see one more rate hike this year and most see an additional 3 rate hikes in 2018. 

Lastly, what the market really wanted to hear more about was how the Fed would tackle the size of their balance sheet which exploded higher due to quantitative easing or QE. This reduction will begin later this year and will continue on a gradual basis over the next several years.    

We will continue to monitor the effects a balance sheet unwind will have on your portfolios. But, in short, we believe this to be another reason to expect rates to move higher over time – which we are prepared and currently positioned for.  

MIT, Yale and NYU sued over charging excessive DC plan fees

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Three class action lawsuits have been filed against the universities for excessive defined contribution retirement plan fees

On Tuesday, August 17, 2016 , the law firm Schlichter Bogard & Denton filed separate class action lawsuits against the three universities in the U.S. District Courts. The suits have been filed on behalf of more than 60,000 plan participants. Common to all three complaints are allegations that each university, as an employee retirement plan sponsor, breached its fiduciary duties of loyalty and prudence under the Employee Retirement Income Security Act (ERISA) by:

  • Causing plan participants to pay millions of dollars in unreasonable and excessive fees for recordkeeping, administrative, and investment services
  • Selecting and retaining numerous high cost and poor performing investment options, which substantially reduced the retirement assets of the active participants and retirees

MIT

In the case of MIT, a 401(k) plan, the complaint alleges MIT's close relationship with Fidelity Investments led to Fidelity's selection as plan record keeper, without any competitive bidding process in violation of the university's duty to act in the exclusive interest of its employees and retirees. Abigail Johnson has been a member of the MIT board of trustees for years and is also CEO of Fidelity, which her family controls. It also alleges MIT placed more than 150 Fidelity funds, including high priced retail funds, in the $3.5 billion plan, despite being a big enough plan to be able to command lower fees. This has allegedly caused participants to pay unreasonable administrative and investment management expenses.

NYU and Yale

In the cases of NYU and Yale, both 403(b) type plans, the complaints allege employees paid excessive recordkeeping fees in addition to selecting and imprudently retaining funds that historically underperformed for years.

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The complaints also state that in contrast to actions by prudent fiduciaries of other similarly sized defined contribution plans, these universities each used multiple record keepers, rather than a sole provider. Consequently, by using multiple record keepers, the universities caused plan participants to pay duplicative, excessive and unreasonable fees for plan record keeping services, the complaint said.

Yale's plan has about $3 billion in assets, while NYU's plan has about $1 billion.

MIT spokeswoman Kimberly Allen declined to comment, while Yale spokesman Tom Conroy could not be immediately reached for comment by press time.

If you have any further questions or want to learn more about fiduciary responsibilities, ERISA, or how we can help you and your company, don't hesitate to contact us.

Fiduciary Rule Goes Into Effect Today

A new law could mean big changes for your retirement savings

June 9, 2017 - Today, the Department of Labor (DOL) officially implemented the "Fiduciary Rule" (also known as the the "Conflict of Interest Rule").

Beginning today, financial institutions and retirement plan advisors must provide advice and act in the best interests of their clients - putting their clients' interests above their own.

Many consumer advocates say the fiduciary rule is a momentous step in the right direction for workers hoping to retire comfortably.

The fiduciary rule lays out “consumer protection standards” that advisors must adhere to. They are as follows:

  • Give advice that is in the “best interest” of the retirement investor.
  • Charge no more than reasonable compensation; and
  • Make no misleading statements about investment transactions, compensation, and conflicts of interest.

The new fiduciary rule will apply only to advisors working with your retirement assets—for most people, that’s a 401(k), or a Roth or traditional IRA.

What the Fiduciary Rule Means For You

You'll See What You’re Paying For

Under the new rule, there’s a push for firms to be more transparent around the fees you’re being charged.

Not sure what you're paying for? Ask your advisor how he or she is getting paid to work with you—and how much their cut will be.

You May Want to Make a Change

Do you think your advisor is a fiduciary? They might not be.

Currently only 10% of financial advisors are fiduciaries.

If you are sensing issues —if you're not happy with your new fee-for-service arrangement, for instance, or you're asking any of the preceding questions and getting fuzzy answers—it may be time to leave your advisor.