Rising Inflation: How Do High Interest Rates Help?
by Trey Finch
A skyrocketing Consumer Price Index (CPI), market volatility, and soaring interest rates are nothing to sneeze at. Everybody knows the i-word is to blame, regardless of how we got here in the first place. So, I have a question for you.
True or false: Inflation is always a terrible thing that brings absolutely no good to anyone.
Considering its current effect on places like the gas pump, I cannot blame anyone for rolling their eyes and muttering, “True, knucklehead!”
Believe it or not, though, the answer is actually false. In fact, I am going to discuss ways that you may be able to benefit from high-interest rates below.
Is There Really an Upside to Inflationary Periods?
Yes, it really is possible for your portfolio to see gains when interest rates soar and cost of living adjustments fall short. I will get into the specifics of this in a minute.
In the meantime, although I have mentioned this before, it bears repeating that all inflation isn’t bad. In fact, Uncle Sam deliberately tries to keep us at a yearly rate of 2%, even when it could go lower.
The reason why is that if the government did not encourage that small amount, our economy could actually spiral into deflation. Where inflation drives prices up, deflation sends them plummeting.
I know: Lowering prices sounds great, but please read on. It isn’t just prices that fall. Production, wages, and demand for goods and services topple with them. Monetary authorities do what they can to restart the economy’s stalled engines, but if that fails, a deflationary spiral begins.
Deflationary spirals get their name from the fact that with interest rates at or near zero, the entire chain of events begins reinforcing the problem it all began with. In other words, a vicious, potentially catastrophic economic circle starts going round and around with no end in sight.
This is why, as challenging as inflationary periods truly are, things honestly could be a lot worse. I am not trying to gloss over anyone’s pain in the wallet by saying this. At the same time, it seemed to bear mentioning.
There really are circumstances in which you can benefit from interest rate spikes. For instance, let’s say that you owe a debt with a fixed interest rate when out-of-the-blue high inflation strikes. What happens?
The value of your debt actually declines—while the cost of your interest stays the same. You still have to pay off your loan, but you wind up doing it with money that has a lower value than the funds you initially borrowed. In this sense, those raised interest rates did you a small favor.
Inflationary Insights & Upsides
When debt values decline, people notice. So, borrowing and lending get a boost. That, in turn, often leads to increased spending on all levels of the economy. While none of this guarantees that challenging times are over, they can be hopeful indicators.
For now, rate hikes may be something of a mixed blessing. Home equity credit, private student loans, and credit cards cost more. Meanwhile, retirement account savings rates could start to rise overall, but that is normally slow-paced.
With lenders incentivized to offer more loans, homeowners looking to refinance could find it a little easier than before to qualify for a new loan. However, there is a serious caveat (so please be careful): The interest rates on those loans could rise, as well.
The better news is that real estate assets can be inflation-proof. If you have a house to sell and demand to live in your area rises, even with rates spiking, your house value is going up.
Barring any strange, property-value-dropping incidents like a volcano emerging within your subdivision, your house is unlikely to lose its worth. Inflation can raise its price, but it cannot reduce it.
It would be nice if wages were so seemingly bulletproof, but they are not. Even as some employers raise salaries, the overall buying-power-reducing effect of inflation means that the additional money barely keeps up with the value of the previous amount.
If you make, let’s say, $30 an hour, you are doing well… until a tank of gas costs $100 or a loaf of bread and a gallon of milk cost $25 together. This is what I mean by our buying power being reduced.
Retirement Planning: Possible Options
Interest rates rise less because of inflation than in response to it. In fact, the term “rate hike” is a literal reference to the government increasing interest as an anti-inflationary tactic. Nevertheless, when you see one, the other is usually nearby.
I am a yank-the-Band-Aid-off kind of guy, so I am about to give you some of the hardest news first: If you are a retiree and your portfolio is heavily invested in fixed-income bonds, they may start losing value, if they have not already.
This happens due to market demand. When interest rates spike, variable (or “floating”) rate bonds gain value. They normally ride hikes like a boat on a rising tide.
Meanwhile, fixed-rate assets do not, since their interest rates are static. As a result, the public’s interest in them cools, shifting to variable-rate assets, instead.
Please do not let this upset you. I am not bringing this up to worry you. On the contrary, I want to let you know that this situation is not without hope.
Retirees in this position should get their portfolios rebalanced as soon as possible, but all is not necessarily lost. The key to weathering inflationary storms is holding positions that favor rising interest rates rather than losing their value.
As a matter of fact, we believe the silver lining to all this is that with a well-diversified portfolio, you could actually see increased returns right now. Despite headlines mourning “Social Security inflation,” your wealth can still be increased.
Let us be your financial advisor in Brentwood, TN, or wherever you call home. Our wealth management firm specializes in working with retirees and those nearing retirement.
The sooner we review your portfolio together, the sooner we can optimize your retirement plan. In fact, by ensuring that it alleviates risks, you can feel secure again about your financial goals.
Reach out and schedule your complimentary appointment today for a face-to-face discussion of our financial services.
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