It’s been a long time since someone other than Alan Greenspan has served as chairman of the Federal Reserve Board of Governors. In fact, Greenspan has been at his current job since 1987. But in a few weeks, we’ll see a “changing of the guard” as Ben Bernanke takes the helm at the Fed. This is big news for economists and policymakers, but what about individual investors in the electrical business? How will you be affected by the emergence of a new Fed chairman?
Before you can answer that question, you need to be somewhat familiar with what the Federal Reserve does, particularly its ability to contract or expand the money supply. For example, if the Federal Reserve feels that inflation is heating up, it may raise the federal funds rate, a key short-term interest rate. This causes borrowing to become more expensive, so consumers are more likely to save money, instead of spending it. In theory, this reduction in demand will lead to less upward pressure on prices, thereby bringing inflation under control. Lately, inflationary fears have been on the minds of the Federal Reserve’s governors, because the Fed has raised the federal funds rate 12 times from June 2004 through November 2005.
Of course, Alan Greenspan could not take these actions by himself; he needed to get agreement from the other Federal Reserve governors. The same will be true with Ben Bernanke. Nonetheless, the Federal Reserve chairman does wield considerable power; when testifying before Congress, Greenspan’s mere words had the power to move markets.
Still, as an investor, you probably shouldn’t place undue emphasis on what the Federal Reserve chairman says, or what actions the Fed takes. You need to look beyond short-term events and make moves that can help you in the long run. Here are two ideas to consider:
Consistently diversify your holdings
When the Federal Reserve raises interest rates, some industries, such as housing and construction, may be adversely affected, while others, such as healthcare and energy, may actually benefit. But you’d find it almost impossible—and quite costly—to constantly juggle your portfolio in response to rising or falling interest rates. Consequently, you’ll be much better off by building a diversified portfolio containing many different types of stocks, along with other investments, such as bonds and certificates of deposit. Over time, you may need to “rebalance” your portfolio to make sure that it is properly diversified and that it still reflects your risk tolerance and time horizon.
Build a bond ladder
When interest rates rise, the prices on your existing bonds will fall. That’s because no one will pay you full price for a bond that offers a lower rate than bonds that are just coming on the market. To build a bond portfolio that offers benefits in all interest-rate environments, you may want to create a “bond ladder” consisting of bonds of varying maturities. When market rates are high, you’ll have short-term bonds coming due to reinvest. And when market rates are low, you’ll still have your longer-term bonds—which typically pay higher rates—working for you.
By following these basic suggestions, you can help stay on track toward your financial objectives—no matter what’s happening at the Federal Reserve.