A rising interest rate is a sign that the Federal Reserve is confident in the health of the economy. U.S. unemployment has hit the lowest levels since 2001, the housing market is strong, and the Fed’s announced in June they will begin reducing their $4.5 trillion balance sheet that accrued during the financial crisis to boost the economy.
Rising interest rates will affect many Americans – from those who plan on purchasing a home, to those who own bonds.
Overall, some people may see a slight increase in their day-in-day-out bills. The Chief Economist with PNC Financial Services Group stated, “When the economy’s doing really well and the labor market is good and the unemployment rate is falling, that’s when you have concerns about employers hiring and bidding up wages and inflation rising.” (www.bankrate.com)
More specifically, here are some of the main areas where many Americans may feel the impact of rising interest rates.
Planning on purchasing a home? You could face a possible condition that includes both higher interest rates and higher home prices. In May, the average interest rate on a 30-year mortgage was 4.18%. (Source: bankrate.com)
Matthew Pointon, a Property Economist for Capital Economics, predicts that by the end of 2018, mortgage rates may reach as high as 5.5%. Rising rates on mortgages, combined with the estimate of home prices expecting to rise 4.6% in 2017 (according to a Zillow survey of economists) could push the pause button for those considering purchasing a home. (Source: fortune.com)
Savings rates remain lackluster. Banks have been resistant to raising savings rates. According to bankrate.com, the average rate on money market accounts the week of March 15 was exactly the same as that time last year, at 0.11%. The average rate of a 1-year CD in August of 2017 is only 0.583%, a rate that might not be very helpful for many investors. (See chart).
Bonds can still be an essential part of a conservative portfolio. They provide income, although typically more modest returns, and high grade bonds are usually considered more stable than stocks.
If you are retired and relying on investment income to pay the bills, in most cases, it might not be appropriate to invest only in equities. Unfortunately, with current short-term rates still low, it has become difficult to earn very much on your fixed income investments and cash.
Traditionally, an investment in bonds was for yield income. In today’s low interest rate environment, the purpose of purchasing bonds has changed. Now, many invest in bonds for capital preservation. No matter what your method or approach is, all investors need to reconsider interest rate risk, issuer credit risk and purchasing power risk.
Remember, bonds and yields typically move in the opposite direction of each other. When interest rates rise, the prices of existing bonds go down.
Investment Portfolio Monitoring
Although interest rates are still low, with interest rates on the rise, it is prudent for investors to review their interest rate-sensitive investments. This includes:
- Making sure you are comfortable with your time horizons.
- Assessing your risk tolerance.
- Confirming your investments are compatible with both your time horizon and risk tolerance. As advisors, we help our clients review the income producing investments they own. Our primary goal is to match your portfolio to your timelines and personal financial situation.
- Maintaining complete liquidity for all short-term and near-term needs. Liquid accounts in today’s interest rate environment will probably not keep pace with inflation. Although it is always important to maintain a liquid component in your portfolio, you should think about what major expenses you will incur in the next two years and consider keeping a larger than typical liquid pool of assets.
- Reviewing your bond holdings duration. In bond investing, we talk about "duration" as a measure of a bond's sensitivity to interest-rate changes. The longer the duration, the more a bond's price is impacted by interest-rate changes. Typically, bonds with longer maturities have longer durations and vice versa. So investing in bonds with lower duration or shorter maturities can help to reduce your exposure to rising interest rates.
- Considering shorter terms over high yields. Although shorter term bonds yield less than longer term bonds, they typically lose less value when rates rise. A good focus is on bonds maturing in two to three years or less.
- Diversification can potentially limit your risk and can help provide your portfolio stability during fluctuating markets that can bring variability into your investment returns.
It is always wise to monitor your portfolio regularly. With interest rates expected to rise on a regular schedule in the next few years, it is even more prudent to keep a close eye and make any adjustments as necessary.
How Interest Rates can Affect Your Portfolio
If you have questions regarding how rising interest rates can affect your portfolio, reach out to Chatterton & Associates today. Our knowledgeable advisors can help you navigate the fluctuations in interest rates and your portfolio.
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Advisory and financial planning services offered through Chatterton & Associates - The Wealth Management Team, Inc., a registered investment adviser. The Investment Advisor Representatives of Chatterton & Associates also offer securities through Royal Alliance Associates, Inc., member FINRA/SIPC. Planning You Can Trust is a marketing and communications name for financial, tax and estate planning services offered through Chatterton & Associates - The Wealth Management Team, Inc., Grandfield Tax & Business Services, Inc. and The Law Office of James F. Roberts respectively. Listed entities are not affiliated with Royal Alliance Associates, Inc.
This article is for informational purposes only. This information is not intended to be a substitute for specific individualized tax, legal or investment planning advice as individual situations will vary. For specific advice about your situation, please consult with a lawyer or financial professional. You should discuss any tax or legal matters with the appropriate professional.
© Academy of Preferred Financial Advisors, 2017