Survey Says: Your Interest Rate Is Going Up

Financial Markets Wall Street Federal Reserve
Richard Drew/APFederal Reserve Chair Janet Yellen speaking in March. The Fed has signaled that it's edging closer to raising interest rates from record lows in light of a strengthening job market.

"April job gains rebound to 223,000; unemployment dips," blared a recent headline on USA Today. But if you've got money in the stock market, that news may not be as good as it sounds. It could even be the prelude to a market crash.

Here's how.

Good News ...

According to the Bureau of Labor Statistics, the American economy did indeed add 223,000 new jobs in April, while unemployment declined to its lowest level since the financial crisis -- 5.4 percent. What's more, among those with jobs, average wages ticked up 3 cents to $24.87 an hour, marking a 2.2 percent rise over the past year. All of this adds up to a healthier economy, and in the opinion of the Federal Reserve, a healthy economy is one that can withstand higher interest rates.

For months, Fed Chair Janet Yellen has been hinting that the Fed may soon begin raising interest rates -- perhaps as early as this summer, perhaps in the fall. With the economy on the mend, more people getting jobs, and workers earning more at those jobs, it's likely the Fed will begin raising interest rates "sooner rather than later," argues USA Today in another article.

And it's not just USA Today that thinks so.

According to a recent poll by Gallup, 56 percent of U.S. investors expect interest rates will rise either a little or a lot in the next 12 months. Only 7 percent expect to see a decline.

... Becomes Bad News

Noting that interest rates have been "practically zero" since 2006, Gallup warns that any increase "could be a shock to the market and investors who have become accustomed to extremely low rates."

Gallup explains that investors in recent years have avoided money markets and CDs paying minimal interest, putting most of their money in the stock market. This is a key reason that the Dow is now sitting near 18,000. With nowhere else to put their money, investors have been using their savings to buy stocks. This buying has pushed stock valuations up to levels that Yellen described during an interview with the IMF last week as "quite high."

This situation could be especially dangerous for retirees. Gallup notes that nearly 1 in 5 retirees agrees that in recent years they have "put more money in stocks than [they are] usually comfortable with," specifically because the interest rates elsewhere are so low. Raise those rates, and investors might pile out of stocks, sending the stock market into a nosedive.

Granted, investors who are happy with recent stock market returns say they aren't likely to move their money out of stocks, and into CDs and money markets, even if those start paying better interest. (But 23 percent tell Gallup that they will switch.) Even those who say they won't could change their opinion in a hurry if stocks start to tumble -- creating a snowball effect of more and more investors fleeing the stock market for the relative safety of CDs.

What to Do Now?

That's not necessarily a bad thing for you, though. Everyone sees the risk of rising interest rates to the stock market. But so far, few people are acting to avoid that risk. That means there's still time to move to the front of the line and begin preparing your investments for the expected rise in interest rates. A few moves you might consider:

  • Cash out. If your stocks are up, now might be a good time to take some money off the table. Put it in a bank account and then, if interest rates rise to a level you like, you can use this money to buy a CD.

  • Cash out -- then cash back in. Alternatively, money taken out of the stock market today, and stashed safely in a bank account, could be used to buy back into the stock market later on -- if rising interest rates cause stocks to become cheaper.

  • Got a mortgage? Higher interest rates will mean more expensive mortgages. Right now, a 30-year mortgage costs just 3.8 percent interest, according to Freddie Mac. That's nearly a half-percent cheaper than the same mortgage cost a year ago, and more than a full point cheaper than mortgages cost five years ago. If you agree with (almost literally) everyone else that interest rates will rise over the next 12 months, the time to lock in a low rate is now.

  • Owe money on a credit card? If the Fed hikes interest rates, and banks do the same, then the first place we may feel the impact is on variable-rate credit cards. Here's a hint: You don't want to be caught with large unpaid debts on your credit cards when rates begin to rise. While as a general rule, it's always a good idea to cut back on spending, and pay down high-interest debt whenever possible ...

... today, with everyone agreeing that interest rates are moving higher, there's simply no time like the present to get started.

Motley Fool contributor Rich Smith tries to practice what he preaches. He has his mortgage refinanced and his credit cards paid off. (Do you?) Next step: Sell some stocks. If you're looking to buy instead, check out The Motley Fool's one great stock to buy for 2015 and beyond.