This week, I’m talking about how the interest rate decisions by the Fed to raise or lower interest rates impact your retirement portfolio. Before we get into that though, we need to spend today on a very important primer, so you can understand what the heck those talking heads are yelling about, and why it matters when you hear on the news that the Fed cut rates again at this month’s meeting. 

Today, we’re talking about the relationship between interest rates and bond prices. The Federal Open Market Committee - you’ll often hear this committee referred to as the FOMC or the Fed - they meet eight times a year to determine the federal funds target rate. The Fed’s decision to raise, lower, or leave rates unchanged have a direct impact on everything from mortgage rates, to interest you’re earning on your bond portfolio, to your stock portfolio. 

The current federal funds rate is currently just above 2%. That’s very low by historical norms. Over the last 60 years this rate has been closer to 4-6%. And it’s even jumped to as high 20% in 1981, as many of you baby boomers remember. My parents bought their first house that year and paid a 12% interest rate on their mortgage. Can you imagine? 12%! Insane.

Here’s what you need to know about interest rates, other than they ebb and flow and are about as predictable as whether or not the groundhog will see his shadow next year: Interest rates and bond prices have a teeter-totter relationship. 

If you can keep that image of a teeter totter in mind, it will help you remember one of the most important lessons about interest rates and bond prices: When interest rates go up, bond prices go down. When interest rates go down, bond prices go up. 

During the Great Recession, the Fed cut rates to zero. When that happens, bond prices went up, which no doubt helped prop up the value of your bond portfolio, but the downside is that when you looked at the rates you could get on your savings accounts and rates on buying new bonds, it was pretty depressing. Then in 2015, the Fed started raising interest rates again, and have continued to gradually raise rates until this summer when they cut rates in July for the first time in over a decade. 

So as rates have gone up over the last 4 years, you can earn more interest (or yield on your bonds and your savings accounts), but the overall return in bonds over the last few years hasn't been great because the increase in interest rates have caused bond prices to drop - again because of that teeter totter inverse relationship between interest rates and bond prices. 

That’s it for today. Thanks for listening. My name is Ashley Micciche and this is the One Minute Retirement Tip. 

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