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As the "Fed" (in the USA) is getting ready to raise the federal funds rate, is it a good idea (or is it even possible) to try to adjust my 401k portfolio for better returns? I'm speaking in general terms--assume I already have a fairly aggressive mix of investments (more stocks and "growth" type balance, fewer bonds), and retirement is still 15+ years in the future. I work for a typical large corporate employer that provides a fairly limited set of 401k investment options (I've seen this as pretty typical for corporate 401k's). Generally I have options that run the gamut from conservative to risky, but limited choices in each category:

  • Large Cap Growth
  • Large Cap Income
  • S&P 500 and Wilshire 4500 Index funds
  • A couple Foreign Funds
  • Small Cap Growth
  • Small Cap Income
  • A balanced bond/stock investment
  • A couple bond funds
  • A money market fund
  • Target retirement date managed funds at 5-year intervals.

I've googled a few searches, but most investing guides seem to talk about how to change your mix of stocks (more raw material stocks, or invest in companies that profit from loans, such as banks, and stay away from treasury and mortgage bonds), which generally is not an option for 401ks. Are there any strategies for those of us with more limited options?

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    You should maintain whatever diversification strategy you have been following, rebalancing as necessary. Assuming you have a defined strategy. Which you should.
    – keshlam
    Dec 6, 2015 at 4:54
  • @keshlam - Indeed, I realize that is the best approach. With that in mind, however, I'd like to know how rising interest rates will affect my 401k, otherwise I feel my strategy is perhaps ill-informed, or incomplete.
    – Ogre Psalm33
    Dec 6, 2015 at 18:38

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The bond funds should tell you their duration. My 401(k) has similar choices, and right now, I'm at the short maturity, i.e. under 1 year. The current return is awful, but better than the drop the longer term funds will experience as rates come back up.

Not quite mathematically correct, but close enough, "duration" gives you the time-weighted average maturity in a way that tells you how the value responds to a rate change. If a fund has a 10 year duration, a .1% rate rise will cause the fund value to drop 1.0%.

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  • I do remember someone once telling me about a relationship between the fed's interest rate and bonds (and stocks?), but couldn't remember the exact relationship. This clears it up nicely!
    – Ogre Psalm33
    Dec 6, 2015 at 18:40
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I see that you're invested in a couple bond funds. You do not want to be invested in bonds when the Fed raises rates. When rates climb, the value of bond investments decline, and vice-versa. So that means you should sell bonds before a rate hike, and buy them before a rate drop.

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As others have pointed out your bond funds should have short durations, preferably not more than about 2 years. If you are in a bond fund for the long haul meaning you do not have to draw on your bond fund a short time after interest rates have gone up, it is not a big issue. The fund's holdings will eventually turn over into higher interest bearing paper. If bonds do go down, you might want to add more to the fund(s) (see my comment on age-specific asset allocation below).

Keep in mind that some stocks are interest sensitive, for example utility stocks which are used as an income source and their dividends compete with rates on CDs which are much safer. Right now CD rates are very low. This could change.

It's possible that we may be in an unusually sensitive interest rate period that might have large effects on the stock market, yet to be determined. The reason is that rates have been so low for such a long time that folks that normally would have obtained income streams from bonds have turned to dividend bearing stocks. Some believe that recent market rises are due to such people seeking dividends to enhance cash inflows. If, and emphasis on if, this is true, we could see a sharp drop in the market as sell offs occur as those who want cash streams move from stocks to ultra safe, government insured CDs. Only time will tell if this is going to play out.

If retirement for you is 15+ years in the future and the market goes down (bonds or equities), good stuff - it's a buying opportunity in whatever category has dropped. Most important is to keep an eye on your asset allocation and make sure it is appropriate to your age. You did not state the percentages in each category, so further discussion is impossible on that topic.

With more than 15 years to go, I personally would be heavily weighted on the equity side, mostly mid-cap and some small equity funds or ETFs in both domestic and international markets. As you age, shuffle some equities into fixed income (bonds, CDs and the like). Work up an asset allocation plan - start thinking about it now. Don't wait.

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  • Indeed, one of the articles I linked in my question talks about which stocks are interest sensitive (such as utilities), but for corporate 401Ks with limited, generic, options, alas, this is not helpful. I will leave asset allocation for a different question, which is already a well covered topic both on the Internet and on Money Stack Exchange.
    – Ogre Psalm33
    Dec 6, 2015 at 22:56

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