Investors: Adjust strategy as higher interest rates loom

Kern Business Journal
October 2015

It’s not a question of “if.” Rather, it is a question of “when” will interest rates increase? Federal Reserve Board Chairwoman Janet Yellen has held firm to her promise to keep interest rates at an historic low – basically zero since 2008 – until the U.S. economy shows real signs of strength.

Some of those signs now are evident: Weekly jobless claims are at their lowest since 1973. Wages are edging up. The real estate market has returned to its “healthy, pre-recession level.” Inflation is expected to be less than 2 percent in the coming months.

But whenever interest rate hikes occur, Yellen has told the Senate Banking Committee she prefers they are imposed “in a prudent and gradual manner.” Economists take that to mean the federal funds rate, which is a device used by the Federal Open Market Committee to influence interest rates and the economy, will be increased in slight adjustments.

While the Federal Reserve was expected to begin edging rates up in September, an increase did not occur. In a recent speech at the University of Massachusetts at Amherst, Yellen warned the delay should be considered only “temporary” and caused by downward economic pressure caused by a strong dollar, and falling oil and import prices that have kept consumer prices and inflation low.

She predicted an interest rate increase is likely to come by the end of this year and other gradual increases will occur in the future as the labor market improves and other economic signs materialize.

It is critical for people to plan for these future increases by adjusting their savings and investment strategies. There is no simple one-step response to interest rate increases. Rather, it requires a combination of adjustments. And now is the time to seek the advice of a qualified financial planner to help lay out a diversified plan for maneuvering through this tricky investing transition.

Savings and investment strategies during the Great Recession were basically designed to provide safety and to “hold the line” when yields were in decline. Now may be a good time to invest in companies that can increase earnings as the economy gains steam. Some sectors are “historically healthy” during interest rate increases.

Higher interest rates will benefit conservative savers who place their money in bank money market accounts and certificates of deposit, or CDs. Ladder these CDs to benefit from future increases. For example, if you have $250,000 in a money market account, take $200,000 of it and place it in five $40,000 CDs, with each maturing every 90 days. The money from the maturing CD can be reinvested in a new CD with a bigger return as interest rates increase.

Generally the stock market does well when interest rates increase. The increase is interpreted as an encouraging sign that the economy is strong. Study the interest rate winners and losers to help direct your investing.

The common belief is that investments in bonds suffer when interest rates rise. But that may not be true for all bonds. Check with an investment advisor to determine if selective bonds can produce gains.

Financial readjustments should extend beyond investment and retirement savings accounts. Now is the time to evaluate credit card rates. The interest rates charged on card balances can fluctuate with prime rate changes. Reduce card balances and consider changing to a card with a lower interest rate.

Renegotiate your mortgage, or trade your adjustable-rate mortgage for a lower, fixed-rate one. Carefully evaluate your home equity line of credit, or HELOC, which can be very sensitive to rate increases. Lock in lower-rate student loans before the increase.

The looming interest rate increases provide great opportunities and challenges. Now is not the time to complacently sit back and wait to see what will happen.