Last month, the Federal Reserve announced that benchmark interest rates would rise by a quarter of a percentage point with similar increases expected in upcoming quarters. This news comes after almost a decade of keeping interest rates down to close to zero. For workers who participate in 401(k) programs, there will be some advantages and some disadvantages that will come with this change.
For many participants, the fact that rate hikes bring higher returns paid on savings is a good thing. For those investing in mutual funds, higher interest rates are not a good thing but will be welcomed by plan participants who want to avoid as much risk as possible. People close to retirement tend to invest more heavily in mutual funds because of the low level of risk involved.
Human resource experts explain that while some things are predictable, the effects the interest rate increase will have on the stock markets is extremely variable. The increases have some people worried about higher borrowing costs for individuals and businesses. The fact that higher rates bring about more stock market uncertainty makes a higher probability of a stock decline very real.
Higher interest rates can also mean that long-term bond funds, traditionally known to be less volatile than stock funds, are likely to come under pressure due to their value decreasing when new bonds are issued with higher interest payouts.
The fact that bond fund payments come from two sources should help ease some of the concern. One HR expert explained that higher rates could actually boost interest payment and serve as a buffer for negative price returns. Bond funds, in theory, should actually see growth over the course of the next decade.
Higher interest rates are also expected to improve the funding issues for defined benefit pension plans because this trend will lower plan sponsors’ required contributions to achieve full funding.
At the end of the day, 401(k) participants should be looking at the long-term effects since they are long-term investors. Day-to-day and month-to-month changes will happen. Typically, it is expert advice to stick with their savings and investment plan even during periods of market change and uncertainty.
