Financial Planning and Rising Interest Rates
The Federal Reserve is hyper-focused on bringing inflation down, and one of the main tools they are using to do so is increasing interest rates. Rising rates and the threat of further rate hikes, has had an impact on the stock and bond market, and the overall economy. For the most part, the impact hasn’t seemed favorable as investment values have gone down and the cost of borrowing has gone up. If you haven’t looked at borrowing money this year, you may not have noticed how much things have changed in that regard, but it is meaningful.
The average 30-year mortgage at the beginning of 2022 was about 3.25%, and has risen about 2% since then. To put this into context, payments on a 30-year mortgage for a median priced home in San Diego ($875,000) are $830/month higher (almost $10,000/year, which over 30 years is nearly $300,000) now than at the beginning of the year, assuming a 20% down payment. Of course, home prices can, and likely will, continue to be impacted by this change. However, home prices haven’t dropped significantly and by some statistics are still higher than last year at this time (depending on factors such as size, price, and location).
Reduced asset prices and higher borrowing costs have been negative impacts of rising rates, but there is also some good news. For many years conservative investors haven’t been able to make much money on their conservative investments (think cash and short-term bonds), but that is starting to change. Take for example an online savings account that I have; in January the account was paying 0.45% and is now paying 1.75%. Also, a year ago the interest rate yield on the bond market was around 1.4% and is now almost 4%. In addition, I-Bonds issued by the US Treasury (which I wrote about last December) are currently yielding 9.62%. And while the stock and bond markets are down year-to-date, now could be a good time to invest surplus funds you may have, or at least allows you to buy more shares of the investments purchased with regular 401K and IRA contributions.
Given all that has changed this year, it makes sense to revisit and update your financial plans. Revisiting your financial plan is intended to make the best use of the resources you have given the current circumstances.
For instance, I was having a recent conversation with a client that has a 30-year mortgage at 2.25%. Their goal is to have a paid for home in retirement. The strategy to pay the mortgage off has been to make extra payments to accelerate the time frame. However, when you factor in the tax deduction of the mortgage interest paid, they are paying what equates to 1.7%. Circumstances now allow for them to earn an equivalent amount on their cash savings, while having liquidity and flexibility. Additionally, they should be able to beat that return over time without taking too much risk. Changing their strategy to saving more rather than making extra principal payments on their mortgage could allow them to essentially pay off the mortgage faster than they would have otherwise, by earning a higher return and having an ability to take a lump sum and pay it off down the road. Let me be clear, I’m not advocating going out and borrowing a bunch of money to invest (I’ve often been leery of financial planners who do encourage that practice). However, given the circumstances in this example, it may make sense to save rather than accelerate a very low interest loan. A principal I follow in my practice is to be cautious with the use of debt. Often, from a financial and emotional standpoint, I recommend paying off debt with a goal of ultimately being debt free. However, the strategy of how to become debt-free may shift as circumstances change.
In summary, I encourage periodically revisiting your financial plan in light of new and relevant information to make sure you’re making the most of what you have.
