Commentary: On Wednesday the Fed finally took the first step on the journey to normalizing interest rates by raising the discount rate by 0.25% (25 basis points). Thought long overdue by most economists, this interest rate increase, and the ones that will follow, is likely to have the following effects on your 401(k) plan and participants:

1. Higher money market fund rates. Most money market funds have been paying investors 0.01% or less. Mutual fund companies have been subsidizing these funds for years. Higher interest rates are not only good for the mutual fund families, but will be welcomed by your plan participants who are risk-averse or close to retirement and have invested heavily in these funds.

2. Higher U.S. stock market volatility. Future rate increases and when they should occur will continue to be debated. Volatile up and down days in the U.S. equity markets are likely as investors alternatively feel good about rate increases, and boost stock prices, or fearful that increases may force the economy into a recession, resulting in market collapses. The U.S. equity funds in your plan may fluctuate significantly.

3. Falling U.S. stock markets. Many market experts believe that once interest rates start rising, investors who have entered the U.S. equity markets to pick up yield will move back into fixed income securities. This selling pressure is expected to force U.S. stock markets, and likely the U.S. equity funds in your plan, lower.

One or two interest rate increases have probably already been discounted by investors. As a result, the markets may take a ho-hum attitude to the first few increases. However, the media and investment community are very  excited about interest rate increases, so your participants may hear a lot about them. To help your participants put things into perspective, it may make sense for you to share the following four messages with them:

  • Nearly all 401(k) participants are long-term investors who should not be worried about daily, monthly or even annual fluctuations in the markets.
  • Volatile times and periods of significant market stress do not last forever. This too shall pass.
  • It is usually best for participants to stick with their savings and investment plan during periods of market change.
  • If a participant feels a lot of stress about what is happening to their 401(k) account, they should get help before making a change. Encourage stressed-out participants to talk with the investment adviser who works with your plan.

Robert C. Lawton, AIF, CRPS is president of Lawton Retirement Plan Consultants, LLC, an RIA firm helping retirement plan sponsors with their investment, fiduciary, employee education and compliance responsibilities. He may be contacted at bob@lawtonrpc.com or 414.828.4015.

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