So it finally happened, the U.S. central bank raised its benchmark interest rate a quarter of a point this week, which while in line with what economists were expecting, was also a long time coming. One of the key things too look for when the Fed releases their statement is its guidance, which is forward looking. In this particular statement, they stated that “”Monetary policy remains accommodative, thereby supporting some further strengthening in labour market conditions.” What does that mean? Well, it means the low interest rates are still low and is likely to stay relatively low in the foreseeable future.
How does a rising interest rate environment affect one’s path to financial independence?
Well, in general, rising interest rates generally means that it becomes more expensive for banks to borrow from the Feb, which then creates a ripple affect that could affect how customers and business borrow money. For the consumer, this could mean higher credit card and mortgage rates. For the business owner, this could affect their revenues and profits. And if the consumer and the business spend and make less, this would effectively affect the stock market that consists of publicly traded businesses.
One of the key variables to valuing a stock is discounting future cash flows. This is done with interest rate as a key variable. Higher interest rates = lower future cash flows -> lower stock prices. That being said, certain sectors would actually benefit from higher interest rates, these include banks, insurance companies, brokerages, etc.
In a rising interest rate environment such as today’s, it is even more important to own a diversified portfolio, preferably the index. Over the long term, the stock market should be able to absorb different economic cycles.
As usual, if you have any questions, Ask the Fellow!