What Rising Interest Rates Mean for You

When the Federal Reserve raises its key short-term interest rate—the federal funds rate—financial markets often move in response. But the impact isn’t uniform across the board. How could a Fed rate hike affect your balance sheet?

Historical impact of a rising federal funds rate

Here are some common bank and investment holdings to watch as short-term rates trend upward.

Source: Schwab Center for Financial Research.

• Savings: Bank savings rates generally have risen gradually, benefiting investors with savings accounts.
• Short-term certificates of deposit (CDs): CD rates often rise but not necessarily by the same amount across all CDs. Short-term CD rates tend to be the most sensitive to Fed rate hikes.
• Cash investments: Yields on cash investments typically rise, but the impact on various cash-related investments can vary.
• Short-term bonds: Initially, short-term bond prices may drop, but price declines tend to be nominal. However, as existing bonds mature, moving money into new, higher-yielding securities generally boosts income over time.
• Financial stocks: Higher interest rates widen the gap between what banks pay on deposits and charge on loans, which can improve bank stocks.

Source: Schwab Center for Financial Research.

• Mortgage rates: Fixed mortgage rates generally track 10-year Treasury yields, so a higher federal funds rate won’t necessarily drive mortgage rates higher.
• Asset-based loans: Rates on loans, such as pledged asset lines and margin loans, may gradually rise, but asset-based loans still can be a low-cost borrowing choice for investors who can mitigate the risk.
• Stock market: How rising interest rates impact the stock market depends on many factors, such as the pace of the rate hikes and inflation. Dating back to 1946, stocks were (on average) down nearly 3% in the first year of fast rate-hiking cycles and up more than 10% in the first year of slow rate-hiking cycles. Also, while rate hikes are intended to curb inflation, U.S. stocks have historically underperformed international stocks (with turning points lagging by about two years) when long-term inflation expectations are rising, suggesting the relative performance of international stocks may be favorable due to their greater inflation sensitivity. 
• Intermediate- and long-term bonds: Performance has been mixed for intermediate- and long-term bonds during previous periods of Fed rate hikes. As interest rates increase, these bond yields may rise, pulling their prices lower. However, their yields tend to be more affected by growth and inflation expectations than by the federal funds rate as time goes on.

Source: Schwab Center for Financial Research.

• Home equity loans: Rates on home equity loans usually track short-term interest rates and may move gradually higher.
• Adjustable-rate mortgages (ARMs): Short-term rates can also determine ARM rates, so they can be expected to rise as well.
• Auto loans: Often tied to short-term rates, auto loan rates may rise. However, rates can vary depending on sales incentives and other factors.
• Utilities stocks: Utilities stocks tend to underperform as investors shift to higher-yielding fixed-income investments.

Reacting to rising rates

While history can be a guide for how investments may perform when short-term rates rise, there are no hard-and-fast rules when it comes to investing. Establishing a financial plan and building a diversified portfolio based on your goals and risk tolerance can help you weather changing market conditions.