Lower rates, lower returns
Labor Day weekend is a time to celebrate and remember the hard-working men and women who first came together on Sept. 5, 1882, in New York to celebrate a “workingmen’s holiday.”
Labor Day also ushers in fall and as the children and grandchildren head back to school thoughts may turn to tuition. (I’ll address 529 College Saving Plans another day.) We’re always paying our dues, or tuition, in one way or another. Costs associated with real world learning curves are often hefty.
Understanding the financial markets and the economy is a complex matter. More than a quarter century ago, a weathered gentleman fondly called Big Al came before a group of new financial advisors. As our sales manager he would teach us about the intricate financial markets. As we sat in the bull pen at that long ago renamed brokerage firm, he barked out, “You’ll pay big tuition here kids.” Big Al’s since gone on to the great trading floor in the sky, but his timeless teachings live on.
While chewing on his stogie, Big Al introduced us to Benjamin Graham (1894-1976), author of “The Intelligent Investor.” Graham was a notable American Economist, who said “most of the time common stocks are subject to irrational and excessive price fluctuations in both directions as the consequence of the ingrained tendency of most people to speculate or gamble ... to give way to hope, fear and greed.” In other words, fear, hope and greed are great motivators, and not always the right ones.
In the midst of uncertainty asking yourself “what do I know right now” is a great reference point. One thing we do know right now is that Ben Bernanke will continue as Federal Reserve chairman, subject to Senate approval of course.
The Fed Chairman is in charge of monetary policy which strongly influences the well-being of our economy. The “Fed Head” has two tools; the supply of money and interest rates.
The relationship between money supply and prices has a powerful effect on economic activity. An increase in money supply presumably stimulates increased spending by putting more money in the hands of consumers. The trick here is to avoid creating inflation. Inflation is caused by too many dollars chasing too few goods and services leading to increased prices.
The Fed influences money supply by setting reserve requirements, the amount of money that banks need to keep “on reserve” rather than lent out. To meet reserve requirements a bank may need to borrow money, or if it has excess reserves it could lend to another bank for a price. The Fed also purchases Treasury Bills, Notes and Bonds, thereby putting more money into the system.
Federal funds interest rate
The federal funds rate is the overnight lending rate banks charge each other. If money is “cheap” (low interest rates) presumably economic activity will increase. The Fed Funds Rate is set by the FOMC (Federal Open Market Committee) who usually meet eight times a year unless there are extenuating circumstances as there were last year. The current Fed Funds Rate is rate is 0.00-0.25 percent.
Let’s think about what this means to you. Lower rates translate into lower returns on fixed rate investments like CD’s, high quality corporate and municipal bonds. Lower Fed Funds rates usually mean lower rates on mortgages and other types of loans. Presumably inflation and the cost of living remain about the same in a lower rate environment. One door closes and another door opens.
Diet COLA anyone?
COLA stands for “cost of living adjustment.” Social Security trustees aren’t planning any cost of living adjustments for the next two years. SS payments may not increase to keep up with rising prices. No supersizing here!
The Fed Head has the tricky task of monitoring these variables. Add a few more factors like imports, exports, balance of trade payments and currency valuations and its apparent why the role of The Fed is so critical.
Economics is both an art and a science. The emotional components of consumer sentiment and confidence co-exist with monetary policy. Science teaches us that for every action there is an equal and opposite reaction. An example is holding a fully inflated beach ball under water and then, pow! It pops right up and it’s gone? Compare that to an economy where increased dollars are being held onto; we know they’ll pop up somewhere, sometime … A key to risk management is to understand where we are right now and plan for the future. As an educated investor you’ll rely more on logic and reason instead of emotions like greed and fear. Invest accordingly.
This article provided by Darcie Guerin, Financial Advisor & Branch Manager of Raymond James & Associates, Inc. 606 Bald Eagle Dr. Suite 401, Marco Island, and FL 34145. Gulfshore Life Magazine named Guerin as one of the Best Personal Wealth Managers in The Southwest Florida Area for 2009. She may be reached at (239)389-1041, email Darcie.Guerin@RaymondJames.com or visit Web site RaymondJames.com/Darcie.