At long last stock market volatility returns due to rising interest rates. We’ve now seen a more than 60% increase in the risk free rate since its 2012 bottom and things are starting to get hairy. I’ve been wrongly waiting for a pull back since the beginning of May so it’s good to finally get some sanity back in the markets again.

Nobody knows whether rates will continue to move higher from current levels. However, it’s good to layout a what if scenario so we can be better positioned.

Rising interest rates do the following:

* Makes mortgages more expensive. The window to refinance at all time lows has passed.

* Makes car loans more expensive. One shouldn’t be borrowing money to buy a depreciating asset anyway, so all is good.

* Increases credit card interest rates to even more egregious levels. Nobody better have revolving credit card debt unless they are a financial masochist.

* Increases student loan interest rates, depending on what type of government subsidies you receive.

* Makes the stock market less attractive given the opportunity cost to own securities has increased. One of the main reasons why I aggressively invested in equities in 2012 was because the S&P 500 dividend yield was greater than the 10-year yield.

* Cools off the housing market as homebuyers are now hit with an increase in prices from a year ago and rising mortgage payments.

* Slows down consumption growth, which is the main driver for GDP growth in the Y = G + I + C + NI equation.

* Theoretically increases your savings rates and CD rates, but banks will move like molasses to adjust so don’t bet on anything great for a while.

* Leveraged buyouts will decrease at the margin due to more expensive debt financing.

* Makes bonds look more attractive given higher yields.

* Strengthens the US Dollar vs a basket of major foreign currencies.

* Makes you reflect on what’s next.

It’s important to realize that a rising interest rate environment often reflects underlying strength in the economy as the demand for money increases. Money demand increases due to better employment levels, higher wages, positive growth expectations and a host of other factors. It’s the short term adjustment, which which can be tricky to maneuver.

TIME FOR A GUT CHECK ON RISK TOLERANCE

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Back in December 2012 I started geting interested in Apple (AAPL). The stock had fallen from $705 down to the low $500s as investors began to sour on its margins, the CEO, and the competitive landscape with Samsung launching a 5″ smartphone called the Galaxy S4.

One simple investing screen I use to find ideas is to see what stocks have fallen at least 20% in a six month period. From there I identify names to research for potential catalysts that will hopefully prove the market wrong. My thoughts on Apple were simply that they couldn’t ignore the market’s appetite for a large screen iPhone. I also thought they’d begin returning more money to shareholders given their $150 billion war chest. At then 12X earnings with double digit earnings growth and an S&P 500 at over 14X earnings, I thought Apple provided a good risk reward in the low $500s.

After dumping a good chunk of change into the markets in June of 2012, I regrettably let a remaining $40,000 sit in a low yielding money market account waiting for opportunity as the markets kept on rising. I figured keeping some money liquid would be prudent because one never knows what opportunities may arise. Apple looked enticing, but I wasn’t willing to “catch a falling knife.” There had to be an option where I could invest in Apple with lower risk, but with a decent return. Enter the Apple ELKs structured note (the link goes into more detail of how a structured note works).

THE NOT SO SAFE TRADE

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There’s one simple observation I’ve noticed in my journey towards financial freedom. Rich people make things more expensive for the rest of us. Given the supply of desirable necessities such as homes, schools, food, and even water is finite, the rich bid up prices far beyond what the middle class can afford.

I remember back in 1995 thinking $20,000 to go to a private university was ridiculous. Now such a private university costs $50,000 in tuition. Ridiculous again, especially with the internet providing so much free education now. Did the median salary increase by 125% in the past 18 years? No. The median wage actually fell 8.9% from its peak in 1999 to around $50,000 per household. That is a double ass kicking!

I remember wanting to buy a sweet two bedroom, two bathroom, double balcony condo in Manhattan with a view of the Chrysler Building and Madison Square Park for $720,000 in 2000. The problem was I only had one year of post college savings and stock gains under my belt and had to borrow about $50,000 to achieve a 20% downpayment. The cost of the 1,350 square foot condo is now roughly $1.7+ million dollars sadly enough. Just take a look at the price per square foot values of ultra high end property and you’ll see an increasing spread compared to the value of median priced property. Someone with enough money bought the place and is now that much richer as a result.

As my portfolio grew over time, I became much more risk averse with my investments. With the Asian financial crisis in 1997, the Russian Ruble collapse in 1998, the stock market implosion in 2000, and the mortgage market meltdown in 2008, it’s hard not to come away with a more conservative investment style.

Now that I’ve built up a livable passive income stream, I’ve gravitated more towards absolute return once again. So long as I don’t blow up the principal portion of my passive income stream, it’s risk-on. We should strive to outperform the competition, especially if we have the buffer to do so. In this article I’d like to discuss the various benchmarks you should consider using to measure your performance based on your wealth and risk tolerance.

FINANCIAL BENCHMARKS TO GAUGE PERFORMANCE

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