The Federal Reserve said Wednesday it would raise short-term interest rates and keep lifting them this year, moving the central bank into a new, more aggressive phase of draining easy money from the financial system as the economy improves.
WHAT DOES THAT EVEN MEAN?
The federal funds interest rate is the interest rate that banks use as a benchmark interest rate for what they charge to borrow and lend money to each other over night. The Fed has only increased the fed funds rate two times in the last 10 years since the financial crisis. Why?
But, the longer you keep this interest rate low, the greater chance you have of causing inflation. Inflation happens when prices increase more than they should for bread and other stuff you need. Then nobody can afford bread because perhaps wages have not kept up.
So, in order to avoid inflation and the economy “overheating,” it’s time for the Fed to increase the fed funds rate. This will be the third rate increase in 10 years.
It’s kind of a big deal but also not a big deal. The bigger deal is that stocks have tripled since the financial crisis, and now people feel the need to pile in the stock market because they don’t want to “miss out.”
BREAKING: you already missed out. That doesn’t mean stocks won’t continue to go up, but just know that you no longer have the wind at your back. Also, stock funds that rely on dividends (that the underlying stocks pay) might have a harder time since they’re now competing with demand for interest rate-based asset classes (like short-term bond funds).
The good news is with the Fed increasing the federal funds rate we’ll eventually see an increase in the interest rate we’re paid on our money that is sitting at the bank. This lack of yield aka a “normal interest rate” has caused lots of problems for retirees who rely on earning interest so they can pay their bills.
Proceed with caution if you suddenly feel the need to invest in stock funds. Particularly U.S. stocks that are trading at record highs. Look east.
In the end, I just love this retired dentist who goes to investment club meetings not for slick investment pitches, but instead, for the pizza.