The Federal Reserve’s recent interest rate hikes, coupled with Chairman Powell’s latest comments indicating that this is not the end, sends a clear message that until the inflation target of 2% is achieved, the cost of borrowing money will continue to rise, putting increased pressure on liquidation. Unfortunately, this increase in interest rates can impact various investment types, including bonds, stocks, and mutual funds, which can have a ripple effect on your 401K portfolio.
Let’s take a closer look at how the Fed rate hike can impact your 401K portfolio through these investment types. First, bonds are fixed-income investments that offer a steady stream of income to investors. However, when interest rates increase, the value of existing bonds decreases, as new bonds being issued will have higher interest rates, making existing bonds less attractive. If you have bond funds in your 401K portfolio, the value of those funds may decrease when interest rates rise. For instance, a bond fund with an average duration of 5 years and an average yield of 2% worth $10,000 may decrease by around 1.25% or $125 if the Fed increases interest rates by 0.25%.
Secondly, stocks, which represent ownership in a company, can also be negatively impacted by rising interest rates. This is because an increase in borrowing costs can reduce corporate profits, leading to a decline in stock prices. If you have stock funds in your 401K portfolio, the value of those funds may decrease when interest rates rise. For instance, a stock fund with an average return of 10% per year worth $10,000 may decrease by around 2.5% or $250 if the Fed increases interest rates by 0.25%.
Lastly, mutual funds, which pool money from multiple investors to purchase a diversified portfolio of stocks, bonds, or other assets, can also be affected by rising interest rates. As we discussed earlier, the value of existing bonds in the mutual fund may decrease, and some mutual funds may hold stocks in companies that are sensitive to interest rate changes, such as financial institutions. If you have mutual funds in your 401K portfolio, the value of those funds may decrease when interest rates rise. For instance, a mutual fund with an average return of 8% per year worth $10,000 may decrease by around 2% or $200 if the Fed increases interest rates by 0.25%.
In conclusion, it’s essential to keep in mind the potential impact of the Fed rate hike on your 401K portfolio. Diversifying your investments and reviewing your portfolio regularly can help you weather market volatility and achieve your long-term financial goals.
Rixtrema’s Portfolio Crash Test application enables individuals to evaluate their exposure to different potential market situations, such as Fed rate tightening, and to analyze the impact on their investment portfolios. The application is designed to assist advisors and investors in being better equipped to manage and evaluate risks for different market scenarios. To arrange a demonstration of Rixtrema’s Portfolio Crash Test application, please click on the following link.
