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.
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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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