Every Time the Fed Raises Interest Rates, Here's What It Means for the Stock Market

What's got investors up in arms about Fed interest rates? The question is more important than ever. Recently, the Federal Reserve has raised rates by 25 basis points again, and there are a handful of important consequences to that.

In some ways, the stock market is like a mood ring. When investors are optimistic, the stock market turns green, and prices rise. But when investors are pessimistic, the stock market turns red, and prices fall.

When the Federal Reserve raises interest rates, investors typically get pessimistic in the short term. Here's why, and what that means for the stock market.

Stock market investors get pessimistic

Investors tend to react badly to Federal rate hikes. History has shown that rate hikes can precede recessions, such as when the Federal Reserve hiked rates in the 1980s to combat inflation. It worked, and inflation fell -- but the stock market also tumbled.

There are many reasons Fed rate hikes make stock investors pessimistic. Here are three:

• Borrowing: It costs more for businesses to borrow money, which lowers profits.
• Spending: It costs more to borrow money on credit, so spending falls, lowering profits.
• Bonds: Bonds become more valuable, so investors flee to the bond market.

Here's an example of how this is playing out in real life: Yesterday, my housemate said she was no longer using her credit cards because credit card debt has gotten much more expensive to pay off. Now she's not spending as much money at stores like Costco, which hurts Costco's profits. Fed rate hikes are indirectly responsible.

Should you sell your stocks until rates come down?

Probably not, as you'd be on the hook for any capital gains taxes, which are taxes the government charges you for profiting on investments sold. Plus, the stock market isn't set in stone. Like people's moods, it swings -- sometimes dramatically and without apparent reason.

Basically, it's complicated. Short-term predictions are hazy guesses at best. Not even Warren Buffet has a perfect read on the stock market (though I'd bet on him more than on 99% of investors). Long-term investors should consider holding onto stocks for five years or more and only selling when fundamentals change or they meet their investment goals.

Despite rate hikes, the stock market (SPY) is up year-to-date. Over the last 50 years, the stock market has gone up at an average rate of 10%. It pays to hold onto a diversified portfolio of stocks long term. Don't let interest rate fears knock you out of the market -- stay strong.

Brokers offer free investing

When fees go up, free becomes all the more valuable. The best stock brokers charge zero fees for buying or selling stocks. But be wary of opening margin accounts, which let you borrow money to invest. Rate hikes make interest payments much more expensive.

Other perks to look out for in a brokerage account include stock research, retirement accounts, and more ways to earn money on investments. Shop around for the best deals, stick with accounts that offer low fees, and be careful of borrowing. Even when rates are low, carrying debt eats into your long-term savings.