The Federal Open Market Committee unanimously voted to raise the range of the federal funds rate by 0.25% to 0.50% – 0.75% (from 0.25% – 0.5%) on 12/14/2016, citing progress in economic activity and labor market growth. This rate hike marks the first for 2016 compared to expectations for two-to-four rate hikes this year back in 2015.
The reality is the market already jacked up rates for all consumers by a more aggressive 0.5% – 0.75% this year as Treasury bonds sold off post Trump’s victory. The 10-year Treasury bond yield is now hovering around 2.5%, the entry point I’ve been looking for to build a municipal bond portfolio.
With unemployment below 5% for the past year, a level that many economists consider to be full employment, it seems like an inevitability there will be inflationary pressure due to higher wages, higher demand, and higher prices.
Is The Economy Really So Strong?
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.
What I do know is that every time I get deliriously bullish, BAD THINGS HAPPEN. As a result, I’d love for you readers to help provide some prospective and go through this post rate hike check list with me. Read each question and answer it in your head or in the comments section.
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?
No. 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.
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.
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.
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.
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!
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 any reasons not to be fine with an interest rate hike. The Fed isn’t stupid enough to raise too much, too soon. The only thing I’ve realized is that I’m not so deliriously bullish as to aggressively buy more equities. Just my normal investing cadence will do.
As of 4Q2018, the 10-year bond yield is still under 3%. Therefore, the yield curve has significantly flattened, and might invert some time in 2019 as the Fed raises rates a couple more times. Beware, as recessions usually happen within 18 months after an inversion.
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Updated for 2019 and beyond. The 10-year bond yield breached 3% in 2018 and is now closer to 3.25%. Mortgage and credit card rates are up, and we’re late cycle in the bull market.