There's a great deal of conversation happening now about the Federal Reserve's intention to raise interest rates. If you've heard about these announcements or even all of the speculation leading up to them, you may be wondering what it means to you. It's perfectly fine to be concerned about these changes especially if you notice the value of your portfolio changing in the short term. But, it also helps to understand the connection between the Federal Reserve and the stock market? How does one relate to the other?
What You Need to Know About the Fed
The Federal Reserve is the big bank in the U.S. The decisions this bank makes impact a great deal of financial matters within the country. In fact, the Fed's job is to help keep the country on a path towards financial stability. There are plenty of politicians that will tell you how corrupt it is. There are others that will tell you it is not. The bottom line is, the Fed's decisions will impact what happens to your portfolio because they directly impact the stock market's investors.
The stock market is not directly impacted by the Fed. Rather, it is indirectly impacted based on the speculation and decisions investors make as a result of the Fed's actions. The most important area of focus here is on interest rates. The interest rate discussed is the benchmark lending rate extended to all borrowing entities.
When the financial markets crashed in 2008, the Fed lowered this key rate – which impacts every loan out there as well as the fees charged by one back to the next for borrowing. By lowering this rate, it helped to motivate people to borrow and buy again. The result was that it helped to make access to money easier during a tough economic climate. And, it did lead to growth, though it has not been as quickly or as long lasting as once expected.
Now, the Fed is raising this rate again. It did this at the start of the year to as much as 0.5 percent. This remains very low. The move shows that the Fed is confident in the current conditions of the market and that the economy can support itself.
Why Do Interest Rate Changes Impact Stock Markets?
Now it costs more to borrow for businesses, which makes these businesses less overall desirable to investors. In some cases, it leads to people in the stock market divest some of these less-than-ideal holdings. This causes the stock market to see a significant drop. Any increase will hurt stock returns. This means that any time there is a change in the Fed's rates, especially on the move up, it will create a change in stock patterns.
What Does This Mean for You?
The good news is this – in nearly all situations, these changes are short term. As long as the economy continues to recover, the stock marketing will continue to grow. And, it may grow significantly and without the inflated, artificial support of the Fed's very low rates. In other words, there is absolutely no reason to panic if you see your portfolio's value drop as a result of this. Stay the course. Long-term investments are always the best course of action and the less risky no matter what changes are happening within the stock market, the Fed, or otherwise.
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