Interest Rate Shifts and Their Impact on You Financial Plan

00:00
Speaker 1
Welcome to Ewa’s finlit podcast. Ewa is a fee only RAA based out of Pittsburgh, Pennsylvania. We hope all listeners of this podcast will benefit as we deep dive into complex financial topics that we will make simplified for you. And we hope that this really serves as a catalyst so that you can make the best financial planning decisions for your family and also save time. Welcome, everyone. Today I’m joined with Jameson, and we’re going to be talking about what to do if interest rates start dropping. Are there proactive moves you can make in the context of your financial plan to put yourself in a better position? So, James, give us a history of, like, what historically have rates been? What, our average? What’s low? What’s average? What’s high?

00:51
Speaker 2
Yeah. So if we look at history right now, interest rates are six, 7%. They seem really high. If we look back 2020, interest rates are in the twos. Two to 3%, that’s really low. Historically, the average is about four to 5% range. So we’re not too far off of that. I think there’s kind of a skewed bias from, because of the COVID pandemic with how low interest rates were. People think that’s normal and that’s like, I guess, abnormally low. So if we look back at history, keep this really simple. Basically, the Federal Reserve was established in 1913. Federal reserve dictates interest rates based on what’s going on in the economy. If the economy is moving too fast, essentially they’ll raise interest rates if it’s slowing down, the lower interest rates.

01:47
Speaker 2
And so in times of any time of economic uncertainty, depression, recession, generally, rates drop. Anytime that the opposite happens, rates rise. So Great Depression, obviously, interest rates were cut sharply. And then post World War two, interest rates remain low, helped spur some economic growth. And then really the next big event was really in the seventies and the eighties, so high inflation, interest rates started to rise, and at that time, interest rates peaked at like 20%. So that’s, like, pretty hard to even wrap your head around interest rate if you’re going to get a mortgage and it’s 20%.

02:24
Speaker 1
Yeah. You’re also getting 20% in a cd then, too. Right.

02:28
Speaker 2
So there’s some. There’s some positives. Yeah. And then since then, obviously, they’ve come down. And then, like I said, in 2020, with the pandemic, rates dropped drastically. So since 2020, 2022 to 2024, rates have gone up. And now we’re on this. Like it’s really the talk of it. If you look at any headlines right now it’s like, what’s going to happen in September with the interest rates? And I think it’s maybe given a little bit too much of a headline, too much focus that people think that’s going to, like, dictate the whole economy.

03:00
Speaker 1
Yeah. Let’s look at where we are today. So thanks for that background, Jameson. So we’re going to put this slide up for those that are watching on YouTube or the Spotify video. So this chart shows 2000, 420, 20 and 2024. So this, you know, US government bonds in 2004, paying 2.87% in 2020.58% in 2024, 4.43%. So we’re in decade and level highs here. And if we go to, like us, high yield bonds over here on the right, 7%, 7.2% in 2004, 9.44% in March of 2020, and on March 2024, 7.66. So everything. But, you know, high yield bonds here, essentially 2024, the interest rates are at decade level highs.

03:56
Speaker 1
So our tips with what to do if interest rates are high and they’re going to start dropping now, we can’t say that for certain because interest rates could continue to stay where they’re at, they could continue to climb. And that’s all based upon the Fed. What the Fed decides to do if inflation were to kick back in, they’re going to keep them hot, may even raise them. However, under the hypothesis that we are under high rates and the Fed has come out and said we’re probably going to have some rate cuts, what are the best things to do? And this really boils down for us as financial planners, as three things. So the first thing is easy, look at all your debt. And Jamieson, walk us through that.

04:38
Speaker 2
Yeah, I mean, really refinance debt if it makes sense. So if you got a mortgage, took out a mortgage in 2023 at 7%, and rates start to go down in the next year or two, and you can refinance to 4%, usually there’s pretty significant savings. Any type of loan, if you have an opportunity to get a lower rate and save your monthly payments, save the amount you’re paying towards the loan, could make sense. You gotta be aware of there’s generally costs to refinance, there’s loan costs, so it has to be enough of a difference to make up for that.

05:10
Speaker 1
Absolutely. And there’s closing costs involved with that as well. So if you’re going to, at least with like a mortgage, if you’re gonna move in two years anyways, you have to evaluate does the closing cost make sense? For the interest saved, and it maybe nothing. And people move like nine to ten times in America. So the other thing you have to consider is paying thousands of dollars to refinance. Makes sense. If I’m gonna end up moving, is the interest saved over that period before I move gonna be more than the closing costs itself or the investment opportunity on that money upfront?

05:41
Speaker 2
Yeah. And then I would say any type of debt, car loan, anything you have.

05:46
Speaker 1
At all, could be the exception, is really around your federal school loans. If you’re in some kind of forgiveness plan, then you don’t wanna touch those. If you refinance to a private loan, then you’d lose your chance forgiveness. But everything else, what’s the cost to refinance? And then ideally, the lowest interest rate, the better we find. Banks typically push arms where in seven years, five years, seven years, interest rates can fluctuate. Those that did that seven years ago locked in arms for maybe two and a half percent, and now it’s coming due at 7%. Not a good decision. So we typically recommend with long term decisions like that, do a fixed rate. You’re going to pay a little bit more, but you’re going to have the certainty we’re not going to get hit.

06:22
Speaker 1
And that’s a big reason why the commercial real estate in America, especially Pittsburgh, for example, is under a lot of pressure. A lot of banks are taking over the buildings because people are going into foreclosure or receivership. It’s bad decision making upfront, or greedy decision making, trying to save a little bit of money.

06:42
Speaker 2
Yeah. And I think I’ve seen arms being pitched heavily right now because rates are high, people are anticipating they’re going to drop. So the pitches, if rates drop, you’re in a, you know, within seven years, we’ll be at a lower rate. But the reality is nobody has any idea what rates are gonna be in five, seven or ten years. So a lot of times there’s just a lot of risk to, you know, try to do that. And one of the things to be aware of is if you’re not putting a significant down payment down, so let’s say you’re doing a physician loan with nothing down, and you’re trying to get into an arm, you could run into problems wherever you don’t have. You’re going to need like, 20% equity to refinance the mortgage anyway.

07:24
Speaker 2
So if the house doesn’t appreciate, if you’re in a spot where the house doesn’t appreciate or even maintains value. And you know, the term, let’s say you did a five year arm, and the term of the arm’s coming up, and you don’t have that equity, you could be underwater in the house and be in a lot of trouble.

07:38
Speaker 1
Be in trouble. Big trouble. Yeah. So today reminds me of back in March 2020, March of 2001. So right now, if you throw your money in the money market, right now, it’s paying about 5%. Right. I think Fidelity 4.97 at Fidelity, just as an example. So March 2001 moneymarks were paid 5.8%. And then rates started to get cut. So if you go to March 2002, on the slide, money markets were paying 2.6%. So your yield would have cut by 3.2% in twelve months. And then one more year, July of 2002, you were down to 1.8%. So the point is, you know, if you go on any bank and say, I want a one year cd, they’re going to pay five right now, you want a five year cd, it’s going to be under two with most banks.

08:23
Speaker 1
And the reason for that is most big banks that have direct access, they know interest rates are probably going to go down, and they don’t want to lock in that long period. Well, the government hasn’t decided this yet, so that’s why you can go in, like a ten year treasury right now and lock over 4% in. So tip number two would be managing cash. If you have a lot of cash in the sidelines, you want to keep it on cash. Think about locking in a lower interest rate for a longer period of time. So, as example, you have $100,000 in cash, and that’s just an emergency fund. You want to keep some of that liquid, maybe keep 50,000 or six months of expenses.

08:58
Speaker 1
But if you want some sleep well at night, you may want to put that other 50,000 in something that, like a ten year treasury, where it’s going to pay you that 4%. If your 50,000 that’s paying five drops to one next year, you’re going to be pretty upset with the other half. Maybe you lock in at four, and you have that guaranteed four for the next ten years. Now, the downside of that, if interest rates continue to climb, you’re still going to get your 4%, and it’s safe for every ten years. If you try to sell it off before the ten years, you’d have to accept a little bit less, because no one’s going to buy your 4%. If a 5% bond is available.

09:27
Speaker 1
On the flip side, if interest rates do drop, not only are you locking in that 4%, but you could actually then go sell that bond. If rates are now three, everyone’s going to want your force. They’re going to have to pay you above what you paid for it to get that. A lot of clients work on repositioning cash, and our portfolios in general, we historically been about a five year duration with our fixed income. We’re very equity centric investors here at EWA. But for those retired clients, that we need to have that card rail that safe money. So no matter what happens in the market, you’re still going to live your life by design. This brings us tip number three, is evaluating your investment portfolios. You want to have really a layered strategy when it comes to your interest rates and bonds.

10:07
Speaker 1
Just an example. In our portfolio, we’ve extended duration. Now what was below five years is now approaching close to six years because lock in these high rates. But we have one to two years in the short term. So in 2022, when bonds lost 14 or 15%, and you didn’t lose money unless you sold it. But if you had to sell it during 2022 and that was your safe money, was a five year bond, and that’s all you had, you’d have had to take a 14% haircut on most bonds that year. So we still need to have some short term availability, and that’s why we have a layered bond strategy. So if the market’s down and interest rates are fluctuating, you can still have safe money.

10:46
Speaker 1
But then part of that six year duration is made up of ten to 20 year treasury overlay, where we have, if interest rates do drop, we’ve locked interest rates for a longer period of time. So that’s our third tip, is really evaluating your investment portfolio and making sure you’re not asleep at the wheel and taking advantage of locking in some of these higher interest rates before they drop.

11:06
Speaker 2
Yeah, and I would say I’ve seen clients obsess over this a little bit too much. Meaning, the purpose of any type of safe money is to have it available in liquid when you need it. So our philosophy is we want to hold anything, bonds, cash, treasuries, money market, whatever, for financial planning purposes. So if you have a purchase in the next couple years, we don’t need to put it in equities. If you’re getting ready to retire or you’re in retirement, we have that seven year safety net. Obviously we want that safe and liquid, but I’ve seen people obsess over? Oh, I could get a 4% rate here or a 5% rate here.

11:44
Speaker 2
And at the end of the day, I mean, yeah, we want to try to get the highest return we can on something safe that we’re holding, but we just want it to be liquid. And you know, that 1% is really not going to be material for your financial plan, no question.

11:58
Speaker 1
Well, that’s our tips. Reach out if you have any questions. If interest rates drop, make sure you’re in the position to take advantage if they don’t drop. Also, make sure your financial plan is able to withstand whatever changes happen in the Fed policy moving forward. Thanks for tuning in to our podcast. Hopefully you found this helpful. Really hope this is as beneficial and impactful to as many people across the nation as possible. So hit the follow button, make sure to rate the podcast, and please share with any friends or family members that would also find this beneficial. Thank you very much.