Can your finances withstand a Fed rate hike? The Fed Funds Rate (FFR) is at 0% – 0.25% to help combat the recession and global pandemic. However, now the Fed is aggressively raising rates to fight 40-year-high inflation rates.
Usually, when the Fed raising rates so aggressively, risk-assets sell off. Therefore, it’s important to solidify your finances during a Fed rate-hike cycle. Eventually, stocks tend to perform well again after Fed rate hikes, but it may take a while.
Preparing For A Fed Rate Hike
Due to growing inflationary concerns, a Fed rate hike is more and more likely in the cards over the next several years. As a result, it’s good to see if your finances can withstand a Fed rate hike.
In generate, a Fed rate hike is a good sign, as it means demand is robust and money is being spend. A Fed rate hike happens to slow down the velocity of money and make borrowing more expensive. However, sometimes, rich central bankers go too far and crush the economy.
As an investor, I’m always looking for evidence to guide how I should allocate my savings. Not a month goes by when I don’t invest in something. And to be frank, I’m always very cautious before making any investment because I have this tremendous fear of losing money after being burned so many times in the past.
But now it seems like everything is stupendously terrific – like a runaway freight train to mega riches for all! I no longer fear only eating ramen noodles thanks to an implosion in the economy. Instead, I’m thinking about getting outside of my frugal comfort zone and living it up.
I can’t tell whether this more carefree spendy attitude is because I’m about to experience a mid-life crisis, or because my assets have continued to grow, or because of a potentially massive business tax cut that will free up more disposable income.
Everybody Is Feeling Bullish
What I do know is that every time I get deliriously bullish, BAD THINGS HAPPEN. In 2021+, everything felt bullish with tech stocks on fire, small caps doing well, Bitcoin at $55,000+. The YOLO economy is here as pent-up demand is about to get unleashed post herd immunity.
However, as we’ve all discovered in 2022, the good times don’t last forever as Fed rate hikes slow down the economy.
Here are some questions you should ask yourself to keep your head on straight. A Fed rate hike could derail the party and hurt your finances.
1. Is a record high stock market helping your wealth?
Yes. About 25% of my net worth is invested in the stock market.
2. Is a bull market in real estate helping your wealth?
Yes. About 40% of my net worth is invested in the real estate market. Although, prices in expensive coastal cities have started to cool off.
3. Is a strong economy helping your wealth?
Yes. The stronger the economy, the higher the employment. The higher the employment, the more money people have. The more money people have, the more people want to know what to do with it. When more people are looking for financial solutions, personal finance related businesses boom.
4. Does a rise in the Fed Funds rate hurt your financing costs?
Not immediately. I refinanced all my mortgages when the 10-year yield was below 1.6%. I have no revolving credit card debt, HELOCs or student loans. Nor do I plan to borrow any money in the foreseeable future. But the 10-year bond yield has risen and mortgage rates have increased by 2% from their lows in 2020.
5. Does a rise in the Fed Funds rate change how you plan to invest your money?
Yes. I plan to take advantage of higher rates by buying assets that must also offer higher rates to stay competitive. Such assets include municipal bonds, regular bonds, REITs, dividend paying stocks and real estate crowdsourcing investments.
6. Do higher rates help retirees or people who want to retire earlier?
Yes. Higher rates mean you require less capital to generate the same amount of income. The less capital required means the less you need to work and save. You can actually increase your safe withdrawal rate if the Fed starts hiking rates.
At the same time, if you subscribe to the Legacy retirement philosophy, you may want to keep your withdrawal rate subdued.
7. Does higher inflation help your wealth?
Yes. As an multi-asset owner, my assets are inflating with inflation. As a landlord, I have the option of raising rents to keep up with inflation or profit from inflation.
In fact, I believe buying rental properties right now is a good idea. With inflation coming back, you will benefit from not only rising rents but rising capital values.
Inflation whittles down the cost of your debt, while boosting the value of you property. Therefore, buying real estate is smart in a rising interest rate environment.
8. Do higher interest rates make you want to save or spend more money?
Given inflation is supposed to increase, the value of a dollar tomorrow will be worth much less than the value of a dollar today compared to a lower inflationary environment.
As a result, it feels better to spend money now to enjoy life more or buy assets that will ride the inflation wave. Both routes provide a positive benefit.
As a retiree, higher interest rates is also great for passive income generation. Higher interest rates means it requires less capital to produce the same amount of risk-adjusted income. If you follow the Financial Samurai Safe Withdrawal Rate, you can withdraw at 1.6% if the 10-year bond yield hits 2%.
Who Loses In A Fed Rate Hike?
Now that you’ve answered these eight questions in your head or shared them in the comments section, we’ve got to remind ourselves who loses.
The archetypical person who loses can be described as one who does not invest in inflating assets, is a price taker, has poor job skills and does not read personal finance blogs. Therefore, all of you should be continuously saving, investing, learning, hustling, and WINNING!
Renters lose during a Fed rate hike cycle because renters will be faced with higher rents.
Input costs are more costly in a Fed rate hike cycle. For example, the cost of lumber has grown massively during the pandemic as the demand for homes surge.
Even if you are seeing your borrowing costs increase, you will benefit from a rise in income through the myriad ways of making new income to more than offset any cost increase.
As I conclude this post, I still can’t find too many reasons not to be fine with an interest rate hike. There will be some short-term pain, especially if you hold high valuation stocks or companies with a lot of debt. But for the most part, a Fed rate hike general is a good thing.
Related posts:
How To Invest And Profit In A Rising Interest Rate Environment
Where To Invest In A Rising Interest Rate Environment
Should I Buy A Home When Interest Rates Are Rising?
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Refinance Your Debt
If you have a lot of debt, it’s good to take advantage of all-time low interest rates and refinance your debt lower. Check out Credible, my favorite lending marketplace where qualified lenders compete for you business.
Personally, I refinanced to a 2.5% 7/1 ARM recently. As a result, I’m now saving thousands of dollars a year in interest. I also got a new 7/1 ARM for a new home purchase with no fees, thanks to Credible Mortgage. Take advantage of low rates before a Fed rate hike.
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Even if the Fed does hike rates in 2017, borrowing costs should remain extraordinarily low. If you review many credit card contracts, you’ll find that even with some increases, certain interest rates remain constant, as the sum of the index and margin which governs rate changes remains below stated interest-rate floors, so a borrower might not see any effect until rates are considerably higher. Of course, if you are affected, a way to ameliorate the impact of higher interest rates (for any variable-rate debt, like credit cards) is to pay balances down more quickly. For savers, it will take more than a couple of hikes to have much effect on deposit costs as banks are fairly flush with cash and don’t much need to compete for new deposits as yet. One item worth considering is that the Fed currently believes that the interest rate it would eventually like to hit is about a full percentage point below historic norms for the federal funds rate, so even higher market interest rates may not end up all that high.
Sam – rate hikes are just going to take us into a different environment. Stock prices tend to do well during the early part of rate hikes. Jeremy Siegel has done some good analysis on this and is well worth a read. Financial (Banks and Insurers) companies will certainly benefit from the early rate hikes as they can increase margins (banks) and earn more off their “float” (insurers). Companies with net cash (or little debt) on the balance sheet shouldn’t do too badly as well.
Later on in the rate hike cycle, you may see some problems. This is likely to start with higher loan loss provisions for banks, meaning banks get more cautious and you get a credit contraction. Rate hikes also gradually increase the risk free rate which has to effectively re-price all asset classes (stocks, bonds, real estate) lower as investors demand higher returns from those assets.
Of course those comments is how the logic should go but those of us who have been studying financial markets for a long period of time know that markets are not always logical and prices can (and do!) fluctuate all over the place!!
1. Is a record high stock market helping your wealth?
No. I am still in the accumulation phase. I would prefer low prices until I retire in 16 months!
(Technically, my net worth is going up, but it would go up even more if prices stayed the same for 16 months and ONLY THEN went up.)
2. Is a bull market in real estate helping your wealth?
Technically, my net worth is going up. However, that is bad because I’m in the buy and hold rental property business (except for one property I’ll flip), so that just means my property taxes will go up sooner. I would prefer they didn’t.
3. Is a strong economy helping your wealth?
Yes.
4. Does a rise in the Fed Funds rate hurt your financing costs?
No way in hell would I get a variable rate mortgage or HELOC when rates were at historic lows! Plus, house prices should depress over time if rates go up, so they’ll be cheaper to buy and hold for cash (which is how I finance them).
5. Does a rise in the Fed Funds rate change how you plan to invest your money?
Sure, but not at the moment. I’ve already planned how I’ll be investing for the next 2 years and that’s unlikely to change unless we’re talking really big rate hikes. The opportunity cost of not completing my last investment project are too high.
6. Do higher rates help retirees or people who want to retire earlier?
Sure, if they are savers and not borrowers. But it will sure slow down folks with variable rates who have to pay off a bunch of debt before they start saving.
7. Does higher inflation help your wealth?
Yes. We own 6 properties and all will go up in value. Our passive income streams will all keep pace with inflation. (Active income streams – our salaries – probably won’t. They will lag behind by 12 to 18 months at the very best.) Other industries might have very different results on this!
8. Do higher interest rates make you want to save or spend more money?
Save.
I think the big question is #4 (Does a rise in the Fed Funds rate hurt your financing costs?). Higher financing costs don’t hurt Sam because he was able to refinance when rates were low, but it will impact a lot of people who are buying property in the near future.
Maybe. Or maybe the people buying in the future have seen their wealth surge due to the bull market and raises that the higher finances costs don’t really matter.
I’m hopefully that everybody who has been reading FS and other financial blogs for the past several years has refinanced.
1. Is a record high stock market helping your wealth?
No, at least not directly. My net worth is in houses, land, and cattle. This is the case for many in my area.
2. Is a bull market in real estate helping your wealth?
No, Land in Kansas has experienced a substantial drop of ~40% after doubling twice in value from 2001-2014. Housing in my area is steady to declining in value do to the huge oil influence here, and since oil is lower, so is housing.
3. Is a strong economy helping your wealth?
Perhaps, it appears cattle prices and boxed beef prices are on the rise.
4. Does a rise in the Fed Funds rate hurt your financing costs?
No, no credit cards and I refinanced my house 9 months ago.
5. Does a rise in the Fed Funds rate change how you plan to invest your money?
Not so far.
6. Do higher rates help retirees or people who want to retire earlier?
Yes, if they are the type of retiree who likes steady returns from bonds and CDs. Perhaps in other ways too.
7. Does higher inflation help your wealth?
I have assets that inflate, so yes.
8. Do higher interest rates make you want to save or spend more money?
Continue to spend the same personally, and if I were wanting to invest in more land, for example — I would do it now. No reason to hope rates will return to a lower point in the near future.
The interest rate hike will help me. My current assets are mainly equities, and I’m listening to your advice to wait until the end of 2018 to purchase a home. In the meantime, I’ll just pay down debt and build up cash and equities.
Who else loses? Holders of bond funds lose serious principle. I think a lot of people will get hit here. However, I’m not sure I agree with the comments that are directly linking mortgage rates to the FED funds rate. I don’t think it’s so clear. The link with inflation is much more direct. Same with gold prices. I have looked at the data and computed correlations between FED rate and gold prices, and it is weak (results plotted on my web site).
See: The Fed Funds Rate And Mortgage Rates
Even though CD’s are taxed at ordinary income, I’ve been trying to jump on the high yield CD’s that occasionally crop up instead of dumping funds into bonds/munis. I think 2016 was a net loser for all of my bond funds.
Rates artificially at Zero for eight years, masking continued weakness in the economy. Not afraid of the rate hike, am welcoming it as a first baby-step to Fed rate normalization.
FS, love the questions, it is a great checklist and everybody should be able to find something to love and fear. For myself as someone with zero debt, 10% of my liquid NW in equities and 90% of fixed instruments, I’m welcoming higher rates of return as I rotate my ladder.
I’m actually seeing signs of deflation for many years (real wages lower than 30+ years ago, home prices increase based on 2% mortgage payments, labor participation rate continues to decline, gas prices lower today than 10 years ago, etc.). So things like a $15/hr min. wage, large healthcare cost increases, and food costs (4% of avg. household budget) have high visibility, but have been absorbed by greater deflationary pressures. We will see, in the fullness of time!:-)
Oh and in March of 13, we locked in a 15 year mortgage at 2.75 so that is not a concern.