How might rate increases impact long-term investing decisions? What’s the impact of a rate hike on long-term savings?
Former President George H.W. Bush famously said, “Stay the course.” Long-term investors, who may be facing higher interest rates, might want to consider Bush’s words when it comes to their financial planning.
When interest rates (and mortgage rates) start climbing, as they did in late 2016, it can cause fear, especially for people juggling a number of priorities such as raising children, saving for retirement and education costs, and paying mortgages. Any new borrowing, and any current variable rate loan, could get more costly.
Sometimes there’s a temptation to do something quickly to deal with the changing climate. But a measured, cautious approach may be warranted.
“Generally speaking, it’s much of the same,” says Robert Siuty, Senior Financial Consultant, TD Ameritrade. “At end of the day, you have to make sure you’re not taking on unnecessary risk, and that you keep accumulating and saving toward your goal, whatever that goal might be: Retirement, a second home or education costs.”
Moving forward, here are some considerations for long-term investors watching rates climb.
Refinancing applications fell sharply as the 30-year mortgage rate climbed from 3.5% to above 4%. You may already be at a rate you can handle and don’t need to make a move now. If so, perhaps the “stay the course” rule may apply.
But if you’re unhappy with that monthly payment, you may still be in a situation where refinancing makes sense.
“You didn’t necessarily miss the boat,” says Shawn Cruz, Trader Content Specialist at TD Ameritrade. “Some people might still find it advantageous to refinance, but it may differ from person to person. If your personal financial condition has improved and your credit rating has improved, maybe earlier you could only get a 5% to 6% rate, but now you could qualify for refinancing” at a lower rate.
Remember, even 4% remains low historically and may be worth a look. As always, check if costs outweigh potential savings. As rates rise, this equation gets a little narrower, so be cognizant of your loan rate and plan accordingly.
Those emergency funds many of us have sitting in CDs and savings accounts make so little interest that it’s hard to remember the days of collecting 5% on cash. Just because rates are rising doesn’t necessarily mean those times are coming back. Even current rates remain historically low, though the Fed has predicted three more hikes in 2017. Perhaps you’re tired of coming away each year with pennies for every $100, but financial professionals commonly claim it’s a good idea to keep three-to-six months of living funds put away in such accounts, just in case of emergency, Siuty said. For money that remains after that’s in place, fixed income may start looking more attractive. Recently, 10-year Treasury bonds paid about a 2.5% yield. “As interest rates go up, that should benefit savers more,” Siuty says.
It’s easy to get swept up in a rally like the one that followed the election, but long-term investors probably don’t want to let that affect their overall plans.
“Longer-term investors prefer to stick to their discipline and stay the course,” Siuty says. “That means having a well-diversified portfolio across asset classes, and an appropriate mix based on their risk profile. They should also monitor and rebalance as appropriate.”
That doesn’t mean not being cognizant of what’s going on in different sectors as rates rise, however, because it’s important not to let gains in one or another sector push your portfolio out of balance. Following the election, dividend-paying stocks generally didn’t perform as well as some others. That could partly reflect investors moving out of dividend stocks and into less risky fixed income, now that bonds are beginning to offer better yields, Cruz says.
Additionally, rising rates often come during inflationary periods, another factor to watch. “If pressure builds and pushes inflation higher, that could affect more interest rate-sensitive sectors like utilities, and industrials as well,” Cruz says.
In an inflationary scenario, industrial stocks could conceivably be hurt by the higher cost of financing new projects. Utilities could sag as some investors abandon them for higher-yield fixed income, and real estate stocks could be hit by rising mortgage rates. If these sectors start to see a major impact from higher rates, there could come a time to consider moving some funds into less rate-sensitive categories.
But remember, just because the Fed seems to have entered a rate-hiking mode doesn’t mean it’s set in stone. After all, in 2016, the Fed predicted four rate increases and ended up making just one, which reminds us about the value of staying the course.
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