WASHINGTON — Janet Yellen, the head of the Federal Reserve, has been preparing us for a hike in the Fed funds rate likely to occur sometime mid-year. So what does this mean for you and your money? It depends whether you鈥檙e saving, borrowing or investing.
Savers: Not much to cheer about.
The proposed Fed interest rate hike going from 0 percent to 0.25 percent probably won鈥檛 make any difference to the interest offered by banks on money market accounts and Certificates of Deposit (CDs). It鈥檚 unlikely that you will be rewarded with higher interest rates on your short-term savings.
Borrowers: Make your move sooner rather than later.
If you鈥檙e borrowing money to buy a home, don鈥檛 be surprised to see mortgage rates climb higher this year.
The asked three expert sources for their mortgage rate predictions. Freddie Mac and the Mortgage Bankers Association expect the average rate for a 30-year fixed mortgage to reach 5 percent by the end of 2015. Lawrence Yun, chief economist for the National Association of Realtors goes as high as 5.5 percent in 2015.
Now鈥檚 the time to refinance your mortgage, if you haven鈥檛 already, as interest rates may not be this attractive again.
Investors: Four adjustments to consider.
There are four things I recommend investors consider to prepare their portfolios for rising interest rates:
1: Evaluate your bond holdings: Those 鈥渟afe鈥� investment grade bond funds and bond ETFs are likely more dangerous than you may think. 聽Why? 聽There is potential for a big drop in the prices of these bonds due to their sensitivity to rising interest rates and it鈥檚 greater than it鈥檚 been in years.
A 1 percent move up in interest rates could cost you 5 percent in your bond fund.聽The problem is that the paltry 2 percent or so yield in these bond portfolios is about as low as it鈥檚 ever been while at the same time bond maturities in the bond index are as long as they have ever been at 7.2 years.
This means more risk and less protection if rates rise dramatically.聽Investors may want to consider replacing bond funds, which have interest rate risk for those with credit risk. Keep in mind that while this may reduce your exposure to the effects of rising interest rates, the downside is that you may experience more volatility and more correlation to stocks.
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2: Reduce exposure to interest-sensitive equities: Consider reducing your exposure to U.S. REITs (real estate investment trusts), utility stocks and high dividend-paying equities, as these are sensitive to rising interest rates. While they have enjoyed several years of great performance as interest rates fell broadly, that party may be ending soon.
3: Consider reallocating to small company and foreign stocks : With the run up in U.S. large company stocks, your portfolio likely has too much exposure there and too little exposure to small company and foreign stocks, especially if you haven鈥檛 rebalanced your portfolio recently.聽It may be time to consider reallocating some of your U.S. equity exposure.
One reason is that small companies do most of their business in the U.S. in dollars so they don鈥檛 face the same currency headwinds that have negatively impacted large U.S. multi-national companies (Intel, IBM, McDonalds, FedEx, etc.).聽Foreign stocks have been out of favor with investors because of the fear of the rising US dollar. This has generally made them less expensive than stocks in the US, making them a better bargain.
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4: Hold some cash for future reinvestment: While cash doesn鈥檛 currently pay much, and may not even when the Fed begins to raise short-term rates, it鈥檚 still a good idea to keep some cash available for investment when yields do go higher.
Regardless of whether you鈥檙e a saver, borrower or investor, by preparing now, you won鈥檛 be caught off guard when interest rates rise.
