Don't Be Fooled by the Federal Reserve
Last week, the Federal Reserve raised interest rates. NOT!
Interest rates FELL the same day that the Federal Reserve announced they are raising interest rates. How could this be?
The Federal Reserve does not control interest rates, no matter what you may hear or read or watch. This bears repeating: the Federal Reserve is not nearly as powerful as many people fear. Their power is exaggerated by many people, much of the time.
The Federal Reserve lends money to a dozen or so of the largest banks in the U.S. They had been lending money at a zero rate and announced they would start charging a very modest amount more than that, one-quarter of one percent (per year). All things being equal, if nothing else in the world affected interest rates (and countless other factors do), then these banks might raise their rates to their clients, and this rise in rates might affect you and I when we borrow money, whether in the form of a mortgage, a credit card, car loan or any other type of loan. Interest rates that companies pay to borrow money, and pay to bond investors, would rise as well. A nice summary of how this works is here.
Thankfully, the world is not so simple. Janet Yellen cannot flip a switch and the rates we pay, and are paid, on everything instantly increase, everywhere. You might wonder why did rates decline when she said "increase"?
There are a plethora of reasons, you can find them yourself on the internet, some of which will include "stocks decline" and money moved into U.S. Treasury bonds. As money moves into bonds, the price increases, and the percentage yield they pay declines. That is enough for me. The point is, any guess why rates rise or decline is immaterial to what matters to you over your investment lifetime.
The great, if brief, history of interest rates can be summed up with one sentence: interest rates are unpredictable. Not one of us knows what rates will do and many a smart person has looked foolish trying to predict interest rates. For sound financial planning, a Federal Reserve decision is immaterial. We have two factors coming into play; one benefits us as we make decisions and one causes expensive mental errors.
We (you and I) benefit, from living through a historical period of time with the lowest interest rates in the history of the world. We benefit from the 2001 and 2008 financial crises because we survived, largely intact. Still here, we can choose to have confidence that our financial systems, our country, the incredible technological developments, and the spread of democracy throughout the world will help us outlast the next crisis. Or, I suppose, we could choose myopia.
You and I suffer from myopia because we are overwhelmed with omnipresent terrifying news, and it all sounds so important. We struggle to find perspective among the podcasts.
Here is what is important about interest rates: For the duration of our investment lives, interest rates have been declining. They have not risen since the first two years of Ronald Reagan's presidency. We are now facing a turning point where, for rates to get back to their long-term averages, we have to experience a lot of Federal Reserve rate increases, and little else going on, just to return to what we think is normal, based on our 30 years of investment experience. This is not likely to happen in any predictable way. None of us knows with certainty how, or when, or with what rapidity, rates will increase.
We can, and should, take comfort in our recent experience surviving unprecedented financial and investment catastrophes. The riskiest of our investments, stocks, came out just fine. With the wisdom that this experience gives us, we can be confident as the next set of unpredictable, unprecedented experiences causes the press, and their viewers, to panic. Let's look to the future with confidence that investing in good companies will deliver long-term good results, as it has in the past, so it will likely be in the future.
From our A&I family to yours, wishing you the merriest of holiday seasons!