Why The Fed Rate Cut Should Concern You

November 5th, 2007  |  Published in Asset Allocation, Investing

Money magazine has an interesting article about how the recent Fed rate cut language indicated that the Fed was more interested in fighting off a Recession than keeping inflation at bay, which was something it had always had its eye on. When the Fed lowers rates, it does so because it wants to spur growth and it thinks that the growth can be controlled enough that it won’t result in inflation. The Fed started to raise rates the last couple of years because it felt growth was strong and that inflation was a concern, so it increased the borrowing costs and reigned in business growth. It’s a complicated way of saying that when the Fed lowers rates, the risk of inflation goes up and business growth goes up as well. When it lowers rates, risk of inflation goes down and business growth stagnates (in general, specific industries have industry forces at play).

So, the recent rate hike is a concern for retirees because that means the price of goods is likely to go up with inflation. Inflation is the number one concern for anyone on a fixed income, most notably retirees. A recession is also bad but Money magazine makes a great point: “the typical recession has lasted 18 months on average (not including the Great Depression), inflation can dog your finances for a long, long time.”

What can you do?

Position your portfolio so that you can handle inflation as well as capital preservation. By this, they mean that you should be conservative but not too conservative. Treasury bonds don’t yield enough to be worth it, so you’ll want to get into a mix of stocks and bonds to give you a chance against inflation. “Real estate investments, such as REITS or real estate funds, typically perform the best of all types of investments during times of high inflation. But like stocks, they also carry a significant risk of short-term loss.”

It’s tough to know exactly what to do but I think that understanding that the specter of inflation is out there is better than not knowing.

  

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