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Ask a Fool: How Will the Fed's Rate Hike Affect My Investments?

By Matthew Frankel, CFP® - Dec 15, 2017 at 2:01PM

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The Federal Reserve can affect stocks and bonds, but it's not a direct impact.

Q: The Federal Reserve just raised interest rates again. How does this affect stocks and bonds?

The Fed's rate hike doesn't have a direct effect on the stock market, or on bond values. So, the answer isn't as simple as saying, "Rising interest rates will make stocks drop."

But there is often an indirect effect. When the Fed raises rates, it makes it more expensive for banks to borrow money, which in turn gets passed on to consumers in the form of higher rates on things like credit cards, home equity loans, and more. This makes consumers less inclined to borrow and reduces the amount of money that is being spent, which can certainly affect corporate profits.

So, when the Fed raises rates -- especially if it's unexpected -- stock prices often fall in anticipation of this effect.

With bonds, the effect is more predictable. Rising rates generally translate to higher bond yields, which means that prices of bonds fall. For example, if you have a bond that pays 4% and the current market interest rate for similar bonds increases to 5%, yours will be inherently worth less because it doesn't pay as much as newly issued bonds.

One final point: A quarter-point increase is unlikely to have a dramatic effect on your bond or stock investments. The more important thing is the long-term trend, and what's expected to come next. In other words, the Fed's plan to raise interest rates several more times in 2018 and 2019 could certainly have a noticeable effect on your investments, especially if rates end up rising faster than the forecast calls for.

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