Interest rates are a key variable for the economy and the stock and bond markets in particular. In the U.S., the Federal Reserve is the 澳洲幸运5官方开奖结果体彩网:central bank that sets the federal funds rate, which influences other interest rates, to meet its mandate of promoting stable prices and maximum employment. The Federal Reserve holds regular meetings to discuss—and announce—any changes in interest rate policy.

澳洲幸运5官方开奖结果体彩网:Interest rates can also affect your 澳洲幸运5官方开奖结果体彩网:401(k) plan. Knowing how this critical economic factor can affect the performance of your 澳洲幸运5官方开奖结果体彩网:retirement plan can help you bolster your investment returns, and to av๊oid potential losses that could result from chan൲ges in interest rates.

The Issue With Fixed Income

One of the most obvious ways a change in interest rates affects your 401(k) is the rate of interest you earn on 澳洲幸运5官方开奖结果体彩网:money market investments that pay either a guaranteed or a 澳洲幸运5官方开奖结果体彩网:floating interest rate. A💟s the federal funds rate rises or falls, so will the interest rate of the money mark🅺et funds in a retirement plan.

While money market funds will offer higher returns as interest rates increase, the key rule to remember when it comes to bonds and other 澳洲幸运5官方开奖结果体彩网:fixed-income instruments is that when rates rise, bond prices in the 澳洲幸运5官方开奖结果体彩网:secondary market will fall, and vice versa.

As interest rates rise, so do yields on bonds, which are the inverse of the price of the securities. For bonds issued previously at a higher yield, the price in the secondary market will decline to match the yields on newly issued debt with the same maturity. This is due to the fact that a bond buyer in the secondary market is not going to pay full price—or the 澳洲幸运5官方开奖结果体彩网:par value of a bond when it was issued—for a bond that is paying a lower rate when new bonds that are issued are paying higher rates. Buyers will thus demand a discount from the par value before they will buy the older bond in order to make up for this difference.

If you own 澳洲幸运5官方开奖结果体彩网:mutual funds that invest in bonds inside your 401(k) plan, a rise in interest rates will likely lower their share price and 澳洲幸运5官方开奖结果体彩网:net asset value. On the other hand, the income of these funds would likely rise over time as they add new holdings paying higher rates to their 澳洲幸运5官方开奖结果体彩网:portfolios.

Stocks and Stock Funds

Interest rates also play a key role in the price and performance of 澳洲幸运5官方开奖结果体彩网:equity markets. Lower interest rates promote economic growth, while the increased borrowing costs associated with higher rates tend to slow it. Because corporate profits are correlated with economic growth, lower rates provide a tailwind for stocks, while higher ones can slow profit growth and hold down 澳洲幸运5官方开奖结果体彩网:earnings multiples.

However, this logic doesn't always hold. Interest rates don't rise and fall in a vacuum. What's prompting rates to move tends to matter more to stock market investors than the move itself. Interest rates declining because the economy is falling into a 澳洲幸运5官方开奖结果体彩网:recession may not provide enough lift to stocks to offset downward pressure from the contraction in economic activity. Sometimes, stocks continue to grow despite high inter♛esꦬt rates.

Interest Rates and Inflation

Interest rates and inflation tend to move in the same direction. While interest rate moves may lag changes in the 澳洲幸运5官方开奖结果体彩网:inflation rate, they generally move in tandem over time. This is because the central bank will typically raise rates to c💛ombat high inflation, and lower interest rates once inflation has dropped. Though rising interest rates may increase the available yield on your cash and bond holdinꦯgs, accompanying inflation will tend to erode the purchasing power of your 401(k) savings.

What You Can Do

There are steps you can take to limit the downside in your 401(k) plan from changes in interest rates. If interest rates are rising, a short-term 澳洲幸运5官方开奖结果体彩网:bond fund is likely to weather the increases better than one with a longer average duration in its bonds portfolio. You might also consider mꦫoving some of your allocation to stocks into short-term bonds or cash for a time, because the stock market will often pull back when rates start 🧔to rise.

If interest rates start to fall, it may be a good time to look at locking in higher rates by adding longer-term fixed-income offerings. Stocks can do better too as rates fall and the equity risk premium grows, provided rates aren't dropping ahead of a recession that could sap profits and share prices.

The Bottom Line

Interest rates affect many facets of the economy, including your retirement portfolio. Understanding the effects of rate moves on investment assets and reacting accordingly will help you maximize your 401(k) plan's investment returns.