What higher interest rates mean for stocks and bonds

The Federal Reserve has made clear it plans to leave interest rates higher for longer.

So what's an investor to do? Christine Benz, director of personal finance for Morningstar, has a few ideas.

While stocks and long-term-bond prices fell in the third quarter, some assets have held up, she pointed out.

"Investors who hunkered down in cash when they saw yields go up earlier this year or late in 2022 have done just fine," Benz said. "They've been getting very generous yields, and they also don't have principal volatility, a pretty great thing in this environment."

The Fidelity Money Market Fund (which the author of this story owns) yields 5.05%

So will recent market trends continue?

"I think it's an open question," Benz said. "And this is why we've seen this sense that the markets are teetering. They're not sure whether concerns about inflation and interest rates will persist or if we will see some economic weakening down the line."

'Don't play economist' when managing money

To be sure, investors shouldn't "try to play economist in managing their portfolios," Benz said. "There's no ignoring these trends. They affect the world that we live in."

But "I like the idea of staying humble in the face of incoming information," she said. "There's a lot we don't know about how things could play out."

So it's wise to assemble a portfolio that will "stand up to a variety of [economic] outcomes that could come down the pike," she said. "That means not sticking your neck out with long-duration bonds, but not just hunkering down in cash."

Also keep in mind that the Fed may raise rates again, Benz said. Some experts see one more hike this year. "So it's a mistake to assume that the worst is over for interest rates and for bonds," she said.

What to do with bonds and stocks

Looking at bonds, "I like the idea of matching them to your time horizon," Benz said. "If you have a fairly short-term time horizon, you don't have any business being in intermediate-term bonds. You should be in shorter-term bonds and cash for those near-term spending needs."

If you have a longer-term horizon, "it's reasonable to hold intermediate-term bonds," Benz said.

Turning to equities, she says, "I like having a nice long time horizon for them. You should have a 10-year spending horizon in mind."

That doesn't mean "you won't have an opportunity to spend from your equity portfolio sooner. But worst-case scenario, you won't have to," Benz said.

"Think about the probabilities of having a positive return over various time horizons and think about your particular spending horizon."

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