Treece Blog: Why interest rates matterWritten by Ben Treece | | firstname.lastname@example.org
At first glance, the title of this piece seems rather silly; of course interest rates matter. They affect the availability and cost of borrowing money, mortgage rates and more. Unbeknownst to many investors, interest rates can have implications on several sectors, and even a direct impact on your retirement holdings.
The past few months, Federal Reserve Chairman Ben Bernanke has hinted that interest rates may rise soon. The term “interest rates” is very broad, but I am referring specifically to 30-year Treasury rates, mortgage rates, prime rate, etc. When I’m referring to one specific rate, I will make note of which one, but on the whole all interest rates tend to be correlated.
When interest rates begin to rise, investors and consumers who track those numbers will notice a bottom has been reached. Once a bottom has been spotted and a new trend identified, investors and consumers begin to adjust their actions accordingly. For example, if an individual is looking to purchase a new home and is quoted a 4 percent mortgage, but the following month mortgage rates drop to 3.75 percent, they have no incentive to purchase. Contrarily, if rates go from 3.75 percent to 4 percent, buyers will have an incentive to purchase in order to lock in lower rates. These savings can sometimes be in the hundreds or thousands of dollars.
Rising interest rates can also create a spark that ignites an economy’s GDP. For the same reason that home buyers will hold out for a bottom in mortgage rates, businesses will hold out for a bottom in lending rates in order to obtain the cheapest money possible. When companies begin to borrow money, even at rates as low as 4 or 5 percent, they will invest those funds in projects that will earn them more than 4 percent or 5 percent. These capital intensive projects typically involve hiring of new employees, be they full- or part-time. The resulting cycle operates as follows: Banks lend money, adding to their earnings, while businesses use borrowed funds to earn more than the cost of borrowing, depositing gains at the bank, which can then take those funds and loan them out to other businesses looking to grow or expand. This flow of money can be very good for a struggling economy.
Rising interest rates can drastically impact investors’ retirement as well. My opinion on bonds is no secret by this point, as I have written time and again about the dangers that a rising interest rate environment can have on the bond market. Rising yields mean falling bond prices, and bonds are traded intraday just as stocks are. Unfortunately, many investors may not realize that they are exposed to the bond market through their pension or various mutual funds that they own until it is far too late.
Recently we learned that investment firm PIMCO was experiencing record outflows from their flagship bond fund. While this is not great news for those invested in PIMCO, it can be good for the economy. Since rates were at historic lows for such a prolonged period of time, investors were able to exit at the peak and take their gains elsewhere. Most investors who were able to see gains from PIMCO will not let their money sit in cash for too long; they will look for the next value buy and put their money back to work.
Rising interest rates can be good or bad for you as an investor, depending on your holdings. Without proper knowledge, it is impossible to make the right decision for your investments and your future, and we encourage all readers to keep an eye on the bond market and what it means for their personal holdings.
Ben Treece is a 2009 graduate from the University of Miami (Fla.), BBA International Finance and Marketing. He is a partner with Treece Investment Advisory Corp (www.TreeceInvestments.com) and a stockbroker licensed with FINRA, working for Treece Financial Services Corp. The above information is the express opinion of Ben Treece and should not be construed as investment advice or used without outside verification.