We are in the midst of the longest surge of prosperity the United States has ever known. Still, the Federal Reserve has raised interest rates several times during the past few months, and threats of more hikes loom. For those of us tending our nest eggs, the question is, will these rate hikes affect our retirement savings?
Fluctuating interest rates are a natural part of the economic cycle. It is true that rising interest rates and inflation can lead to recession and a dip in the value of your investments -- but cheer up. In the short term, we can take comfort in the fact that recessions rarely occur during election years. What's more, economic growth cycles are much longer than periods of recession, so even if a recession hits, economic recovery is probably just around the corner.
My mother used to say that a balanced diet was the key to good health. Balance is just as important for investors, and it's called diversification. The idea is to balance the investments in your retirement plan so that losses in some assets will be offset by gains in others.
The benefits of diversification will be apparent if interest rates, which have been very low for years, increase by several points. When interest rates rise, bond prices plummet and bond yields rise. It may be a good time to add to your bond allocation. Right now, bonds with shorter terms are paying more than long-term bonds, so consider buying bonds that come to maturity in 5 to 15 years, rather than 30-year bonds.
Buying bonds has become easier than ever. You can choose a bond fund (you may even have one in your 401(k) plan choices). Bond funds are categorized by type of bond (say, government or corporate) and by duration (short-term, intermediate-term and long-term), so you should be able to find the fund that best suits you.
Search for funds online on:
You can also buy government bonds online at TreasuryDirect.
Mixing Up Your Stocks
Different sectors of the economy do better at different times. For example, when oil prices rise, energy stocks may get a boost but airline stocks may decline. So it makes sense to diversify the stocks in your portfolio. Maintain a smattering of every industry in your retirement plan.
Tweaking your portfolio may be a good idea, but the worst thing you can do when you think that recession is coming is to drastically change your strategy. Avoid the temptation to stop investing, or to convert your retirement funds to cash and wait out the storm. Hunkering down is a good idea when a tornado is approaching, but it's bad advice for a long-term investor.
No one can time the market. By the time you realize that the market is sliding, the decline may be bottoming out. If you sell, you may miss the rebound. History shows that much of the gain from a bull market happens at the very beginning of a recovery, so sitting on the sidelines worrying is the worst strategy of all.