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Higher Interest Rates Bad For Some; Great For Others (Hint: Retirees)

Higher Interest Rates Bad For Some; Great For Others (Hint: Retirees)

April 26, 2024

While direct borrowers are hit the hardest when the cost of borrowing increases, the indirect effects of higher interest rates can also be detrimental. Higher rates can adversely impact the main components that fuel economic growth – labor, income, spending, manufacturing, and inflation.

  On the other hand, if you are on the lending side of an interest rate-related transaction, such as a bank or other institution whose business is borrowing and lending, higher lending rates can be profitable, provided borrowing costs are lower.  

 The group that probably benefits the most from higher rates is employees and individuals with diversified employer retirement plans and savings, brokerage, and individual retirement accounts. These long-term investors are not borrowing funds to lend; they are not borrowing at all (unless “margin” is used); they are trying to get the highest returns.

Investors can take advantage of the higher returns issued by banks (CDs), government agencies (Treasury Bonds), Corporations (investment grade bonds), and other money market-type funds. As with any lender, higher interest rates mean higher income.
 Here are some other benefits available to holders of higher interest-paying investments (CDs, bonds, money market funds) in their diversified portfolios:


*) The liquid cash reserves for emergency purposes or funds earmarked to fund short-term goals have historically provided minuscule returns. However, the rates for a 30-day CD today range from 4.50%     to  5.25%.¹ The inflation rate for the last year was 3.5%². The returns on emergency reserve funds are greater than the inflation rate – a rare happening.
¹ Source: Bankrate
²  April 2023 to March 2024 per Consumer Price Index.

 

*) The higher short-term rates allow you to increase your overall portfolio return without increasing portfolio risk since CDs and Government Bonds are backed by banks, and the US government backs the government debt. Longer-term government, corporate, and municipal bonds also yield higher current returns. Constructing portfolios to include short-term and long-term bonds can provide greater diversification, lower risk, and higher long-term expected returns.

*) Retirees, who often rely on their investments for income, can benefit from higher interest rates. Using fixed withdrawal rates, they can receive income that increases or keeps up with inflation. This can lead to higher income payments, providing a sense of security and stability.

*) Interest earned from bonds and CDs are taxable as ordinary income in non-qualified accounts (brokerage, trust) and tax-deferred in qualified accounts such as 401(K)s and IRAs. Allocating interest-bearing investments to tax-deferred accounts can allow greater tax-deferred growth since no tax is due on the earnings until withdrawn.

At Carr Wealth Management, we help clients achieve their financial goals by emphasizing straightforward, low-cost, and tax-efficient planning and investment strategies. Please review our website for more information about our services or call us at (925) 484-1671 or email us to ask a question or schedule an appointment.

  No investment process is risk-free; no strategy or risk management technique can guarantee returns or eliminate risk in any market environment.  There is no guarantee that our investment processes will be profitable.  Past performance is not a guide to future performance.