With all the recent talk about interest rates, employment, and volatility, I thought I would clear some things up.
Is an increase in interest rates good or bad? Is full employment good or bad? Is high-volatility good or bad?
Let's find out.
An increase in rates is both good and bad.
First the good.
The Federal Reserve (FED) calls for an increase in interest rates because the economy is looking strong. Good. With the economy plowing forward, the risk of inflation becomes more apparent.
Inflation is the increase in the price of goods and services, eventually making everything more expensive.
The FED raises interest rates in an attempt to calm down inflation in order to keep the cost of goods and services down. This should help keep your everyday items relatively affordable.
An increase in interest rates also means an increase in interest payments from bonds, CDs, and savings accounts. This comes as a benefit to savers. If you continue to save money, you should get a little more back on your money through increased interest payments. This is for new money, however. Any money you had before the rise in rates will continue to see the same payout, the reason why is below.
Now the bad.
Bond prices and interest rates have an inverse relationship, so when interest rates go up, bond prices go down. If you are a bond investor, you will see a decrease in your principal (the money you invested in the beginning, not including interest payments).
Higher interest rates also slow the economy and the stock market. The reason, borrowing is now more expensive. People and business that lent money from banks, institutions, and credit cards will now borrow less. The decrease in borrowing will effectively decrease the supply of money in the economy, so people will be buying less.
Regarding businesses, the reduction in borrowing will give a business less money to fund new projects and such. This could have a negative effect on their bottom line. Less money could mean less revenue, which could lead to a decrease in the stock price. If enough businesses stock price decreases, we could then see a decrease in indexes (like the Dow or the S&P 500) because indexes are made up of individual companies.
With regard to credit cards, most credit card companies borrow money using an APR interest rate. APR is a variable rate, which means it can change. If the FED raises interest rates, the APR for credit cards will go up. At this moment, we have the most credit card debt in history. If credit card rates increase, there will probably be more people who can't afford to make their payments. The result is defaulting (failure to pay) on their debt. This could cause a domino effect of an increase defaults.
This is essentially what caused the Great Financial Crisis. Rates started to increase and more and more people couldn't make their mortgage payments because they couldn't afford their houses in the first place. The resulting avalanche caused the financial crisis.
This is obviously the worst case scenario and I'm not saying this could happen, but I wanted to give a clear and relatable example.
Conclusion = Interest rate increase is good and bad.
Sorry to disappoint, but full employment is also good and bad. A much more concise answer, however.
Full employment is good because more people have jobs. That' awesome! More people are working, which means more people are making money, which means more people can provide for themselves and their families, which means more people contributing to the economy.
Statistical data, found here, shows that when unemployment is below 5%, it usually spells for low stock market returns over the coming years.
High volatility, in most cases, is a good thing. Dramatic ups and downs in the stock market are incredibly hard to stomach and this is where most investors get into trouble. They see the price go down by 5%, 10%, 20% and get scared into selling. All to see it come right back up.
A seasoned investor knows that volatility creates buying opportunities. If you've been waiting to get in on a stock or an ETF and volatility picks up, you could see a lower price in the position you've been watching, due to the dramatic ups and downs in the market.
If you did your homework on your investment and you have a long-term time horizon, you shouldn't worry about the short-term swings in price. Obviously, if you have a shorter time horizon or some horrible news about your investment comes out, it might change your reaction.
All-in-all, high volatility is a good thing because it creates buying opportunities for patient investors.
Note: Invest according to your own risk tolerance and time horizon. All investments come with risk including loss of principal.
Interest rates, employment, and volatility have been at the forefront of recent headlines. Knowing what each of these items means and how they affect the stock market is important to understand. Please, if you have any other questions about what I've written here or what you've seen in the news lately, send me a message and I'll do my best to help you.
Disclaimer: This was written for informational purposes only. The topics discussed were strictly the author's opinions and should not be used as advice. Do not make investment decisions based solely on what you read or hear.