What will the new Fed chair mean to investors?

President Obama has nominated Janet Yellen, the current vice chairwoman of the Federal Reserve, to become chairwoman of the Fed when Ben Bernanke, the current chairman, ends his term on Jan. 31. What does her appointment mean to investors?

Many experts think that Yellen is likely to continue the policies favored by Bernanke, such as a determined effort to keep short-term interest rates at historic lows until the unemployment rate drops to about 6.5% — which may not occur until 2015. Consequently, if you invest in short-term bonds or certificates of deposit (CDs), you may not be seeing significant changes in the rates you receive.

The Fed has less control over long-term rates, but in an effort to stimulate the economy, it has attempted to keep these rates low by purchasing about $85 billion in bonds — a mix of Treasury bonds and mortgage-backed securities — each month. Although Yellen has supported this program in her role as vice chairman, it’s unclear how much longer the bond-buying will last and, in fact, it may even be reduced before she takes over as Fed chair.

If this happens, you will want to pay close attention to your long-term bonds, or bond-based mutual funds, because if long-term rates go up, the value of your bonds will drop, perhaps sharply, because no one will want to pay full price for your bonds when they can purchase new ones at higher rates. Consequently, you may need to adjust this part of your portfolio.

The Federal Reserve’s ability to adjust interest rates in response to economic growth and inflation attracts a lot of attention. But the Fed also helps to regulate our overall financial system — a role that has gained increased importance since the financial crisis of 2008.  Yellen’s background and philosophy offer some clues as to how she might approach this aspect of her Fed leadership. She has strongly advocated the idea that proper regulation can help prevent abuses in the financial markets, thereby contributing to fewer disruptions.

Yellen has been a good prognosticator. She warned about the housing bubble well before it occurred, and she correctly predicted the somewhat slow recovery from the financial crisis and the accompanying low inflation.

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In any case, no matter what course Yellen charts for the Federal Reserve, keep in mind that the Fed is only responsible for monetary policy, which, although important, is not the only factor affecting financial markets — and, subsequently, investors. The president and Congress manage fiscal policy, which covers spending and taxation issues, some of which can have a direct effect on your investment decisions. For example, the tax laws governing dividends and capital gains are periodically changed, and these revisions can certainly cause you to at least review your portfolio, and possibly make adjustments.

We are currently in a strange situation in which the U.S. Treasury is approaching its debt limit. Without congressional action to raise this limit, the U.S. would be in virtually uncharted waters as far as its ability to honor its debts — and make interest payments to those investors who have purchased Treasury bonds. Many experts say that if this happens, the repercussions to the financial markets could be serious.

As an investor, you need to focus on those things you can control, no matter who heads the Federal Reserve, what fiscal decisions are made, or even what periodic crises may erupt. And that means you need to build a diversified portfolio that’s constructed to reflect your goals, risk tolerance, and time horizon. While you need to be aware of external events, and how they might affect your portfolio, you’ll find that the changes in your life — marriage, new children, new job, or impending retirement — will ultimately have a far greater impact on your long-term investment strategy.

This article is provided by Lauri Binius Droster, CFP, senior vice president and a financial adviser at RBC Wealth Management. The information included in this article is not intended to be used as the primary basis for making investment decisions. RBC Wealth Management does not endorse this organization or publication. Consult your investment professional for additional information and guidance.

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