The economy in 2022 has set multiple records, first with the highest inflation rate in 40 years, and now with the highest Federal Funds rates since 2008.[1] The US Federal Reserve has now raised interest rates seven times this year, reaching a total of 4.25% this month as the Central Bank scrambles to curb rampant inflation.[2] Higher rates have a ripple effect through the economy and their impact should play a part in your decision making both before and after retirement. Here are few ways these rates will impact you as a retiree:
- Declining Investment Account Balances
Rising interest rates – in other words, rising costs of borrowing money – tend to push stocks lower. [3] There are a few technical reasons around how stocks are priced that play into this. Then there are the easier to see behavioral reasons that stocks slide, such as investors cashing out their stocks when they see interest rates rise and expect a recession. All that selling can create downward pressure on stock prices.
Beyond that, the cost of doing business rises. Debt servicing costs go up as interest rates rise and this puts pressure on balance sheets. Margins shrink which impacts earnings, and lower earnings also tend to correspond to lower stock prices.
Other investments also start to look attractive again at interest rates rise. For example, Treasury Bonds weren’t all that exciting when they paid 1-2%/year. But yields on some treasuries are now in the 4-5% range. Some investors who felt they had no choice but to buy stocks may be tempted to sell and reposition their proceeds back into bonds. Stocks finally have competition again, and their price is likely to drop to reflect it.
All this culminates in the value of your accounts going down. While painful, it isn’t necessarily all bad. Markets can get overheated and corrections are part of a healthy balancing process. Dips have always been fleeting historically as economic revivals ultimately take hold, though it usually feels like forever and a day before they finally come around!
As a retiree, selling out at the bottom locks in your losses and makes it difficult if not impossible to recover from. Staying the course and sticking to a rebalancing plan, however painful it may be in the short run, tends to produce the best financial outcomes over the long run.
- Saving Account Rates Rise
The old saying “cash is King” is never truer than when interest rates rise. Banks make their profits on something known as the net interest margin, which is the difference between what they earn on the money they loan out and the interest they have to pay you on your own deposits. It’s a delicate balancing act, as the only way they can get any money to loan out in the first place is by paying consumers enough to attract their deposits! When interest rates rise so do those deposit rates, since banks are competing for your dollars against other investments like the US treasury bills that are suddenly paying more. Money you may have felt compelled to invest in the market when there was no safe, viable alternative can now flow back to the safety of higher-yielding savings accounts.
- Variable Rates You Must Pay Also Increase
When rates rise, you may see higher credit costs, such as those on credit cards or variable mortgage loans. If you are retired or planning to retire and are still paying off debt, then you may want to examine your payment plan to see if you have an Adjustable-Rate Mortgage (ARM). This may result in higher monthly interest charges. Regardless of whether it’s an adjustable-rate mortgage or a credit card plan, an increase in interest rates might result in higher expenses. Your focus on debt reduction must become more and more acute as interest rates continue to creep higher.
The future of the economy in relation to inflation and interest rates is unknown. With borrowing costs predicted to increase further, the effects on your wallet may compound. It is important to know where you stand and how best to go about your financial plan amidst this changing economy. For better clarity on your circumstances, sign up for a complimentary review of your finances with us today.
[2] https://www.cnbc.com/2022/12/14/fed-rate-decision-december-2022.html
[3] https://www.fool.com/investing/2022/09/19/feds-rate-hikes-impact-your-retirement-plan/
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