Money Talks: Interest rates, a double-edged sword
Recent headlines for investors here in paradise have gotten the attention of many who spend most of their financial lives concerned about anything other than interest rates. As we move through nearly a decade record low interest rates, many have simply forgotten what life could be like with higher rates, especially with regards to the ever so coveted bank deposits.
When we think of interest rates and their potential impact on our daily lives, the reality of a double edged sword is often lost on the average investor. Of course, we can embrace the fact that higher rates make for better bank deposits while at the same time slowly put downward pressure on the stock markets. On the other side of the double edged sword, we also embrace the fact that extremely low interest rates remove any value of owning a bank deposit, while at the same time, often lower rates are associated with stock market success. Certainly the last seven years will reflect this phenomenon.
Recent conversation with retired investors revealed a disturbing trend that many have simply forgotten as to the pros and cons of higher interest. Here is where we remind investors to “Be careful what you wish for … you may just get it … ” This certainly translates retired investors who desire a rapid and drastic increase in rates so that they may relive the good old days when the bank could generate double digit returns with a simple time deposit; i.e. CD’s.
Let’s reflect on perhaps all-time highs for bank deposits / inflation in the modern era of saving and investing to 1977-1981 and the Jimmy Carter administration in the white house. The little fact lost on many is that significantly higher rates generally come with a price … inflation and double digit mortgage rates. For a little perspective, inflation in 1978 was around 14 percent while today we are around two percent. Yes, although we may have been able to secure a 16 percent Cd back in the day, we also were operating in an economic environment with hyper-inflation and mortgage rates nearing 18 percent.
Imagine the financial difficulty of maintaining a mortgage of roughly 18 percent in today’s environment. There is little doubt this would have a devastating effect on all things real estate. The costs associated would far outpace the average Americans ability to maintain a primary residence. Yes, double edged sword indeed.
Fortunately, it would be a long shot to fall into such a catastrophic rate debacle in today’s highly regulated and monitored environment. In other words retired investors, don’t expect any 16 percent CD’s anytime soon … and for good reason.
We are slowly coming to the resolution as investors that the other side of the sword when it comes to low rates is the fact that, at some point rates cannot go any lower and can only go up from here. As important as it is for the Fed to control inflation by controlling interest rates, their ability to walk the fine line of complementing the markets without upsetting them can be a tall order as we have seen with the extreme caution that the Fed has exercised thus far as we head into the new presidential administration on the heels of an nearly unprecedented nine year bull run for stocks. Here is where we could see the double edged sword swing the other way and send shock waves across the entire financial community.
Again, it has been so long since investors have even had to consider the interest rate environment that many may simply sit idle until potential carnage and losses occur. Remember, when rates go up, the value of existing bonds goes down…always has and always will. Now may be a good time to address portfolio allocation issues and the total exposure to bonds.
Fortunately, many educated investors who have seen the light of true diversification by the addition of both managed futures with little to no market correlation, as well as the insured index strategies which capture market gains while avoiding market losses. Certainly this leads to the life of a SWAN, Sleep Well At Night.
William F. Hague is a managing partner of Hague Wealth Management; 239-389-1999 or WFHague@earthlink.net. The opinions and observations stated above are those of the columnist.