Frederick Fisher: A few things you need to know about rising interest rates
July 22, 2018
It has been 10 years since the great recession. As a way to stimulate the economy, the Federal Reserve lowered interest rates drastically, in hopes that businesses and entrepreneurs would borrow money and invest in the economy.
Now that the economy is on the mend, the long awaited rise in interest rates is starting to take shape. The current Fed rate is 2 percent, and could very well rise to 2.5 percent by year's end.
Many investors want to know how this may affect their finances and ultimately their retirement. One such hypothetical couple are Joan and Steve. They are in their mid-50s and are planning to retire in the next 5 to 10 years. With interest rates on the rise, they want to know how they might be affected.
We discussed things that they should be aware of when planning for retirement in a rising interest rate environment. The first item was to understand that interest rates and bond prices have an inverse relationship.
In other words, when interest rates rise, the value of bond holdings declines. Being very conservative investors, Joan and Steve had a significant part of their retirement assets in bonds and bond funds. We recommended that they review their bond holdings and possibly trim their allocation and review their mix of bonds to determine their exposure to interest rate risk.
The second item we discussed was that borrowing costs will rise. As the fed raised rates, other interest rates may go up, like mortgage and auto loans.
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A rise in mortgage rates would not affect them since they refinanced a few years ago into a 30-year fixed loan at 4 percent, and were planning on staying in their home for the long haul. However, they were thinking about getting a new car in the next few years.
In order to take advantage of the current lower auto rates, we advised them to possibly move up their timeline and purchase a car now rather than waiting a few more years. We advised them to shop around and were confident they could get a 5-year loan for under 5 percent and possibly 0 percent if the manufacturer was running a special.
This lead us to discuss the next item to be aware of with rising interest rates: that rising interest rates are a method to keep inflation in check.
As the economy grows, inflation can start increasing and the Fed raises rates to make sure the economy does not overheat. So, in addition to locking in lower borrowing costs, Joan and Steve may find better prices now than they would in a few years.
Lastly, we advised them to have their stock portfolio reviewed. Over the last few years, many investors had been investing in blue chip stocks that were paying high dividends, between 3-5 percent.
Frustrated by low interest rates on bonds between 2-3 percent, investors allocated money to stocks that had dividend yields higher than their bonds, taking on risk that they would rather avoid. When interest rates rise, bank certificate of deposit rates will rise, and may attract more of the conservative money that is now in stocks. As conservative investors, Joan and Steve may want to review their portfolio for reallocation.
Our overall recommendation was not to fear rising interest rates, but to adjust to them. Knowing how your investments may be effected is key. Provided the Fed does not raise rates too quickly, investors should have time to adjust their portfolios according to their risk tolerance and time horizon.
Should you want your portfolio reviewed, contact our office and discover the difference when you thing beyond investments.
This is a hypothetical example and is not representative of any specific situation. Your results will vary. The opinions voiced in this article are for general information only and are not intended to provide specific advice or recommendations for any individual. Frederick Fisher is a Certified Financial Planner Practitioner, and Insurance Agent with Ostrofe Financial Consultants, Inc., with clients in 31 states. This information is not intended to be a substitute for specific individualized tax advice. We suggest that you discuss your specific tax issues with a qualified tax advisor. Frederick Fisher is a Registered Representative with, and Securities offered through LPL Financial, Member FINRA/SIPC. Investment advice offered through Ostrofe Financial Consultants, Inc., a Registered Investment Advisor and separate entity from LPL Financial. For questions or suggestions, contact Frederick at 530-273-4425, or email@example.com, or visit ostrofefinancial.com. Branch address: 565 Brunswick Road, Ste. 15, Grass Valley.
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