Update on Interest Rates

Since my last post, the Federal Reserve has raised rates 3 times, so short term rates are getting closer to their long term historical rates. I think we can all agree that it is uncomfortable having money in a bank savings account earning 1/10 of 1%, when it will take at least 2% more in a year to buy the same amount of stuff, due to inflation.

In the short term, increases in interest rates hurt the principal value of bond funds. As each bond in the portfolio matures, and is replaced with one that pays the current, higher, rate, the annual income will go up correspondingly. There is a measure called "Duration" which helps measure this effect. If you'd be interested in attending an online session to learn more about this, drop me a line and let me know.

 

When Will the Fed Raise Rates?

It seems I receive another email almost daily with speculation about whether the Federal Reserve will raise the Federal Funds Rate. It has been going on so long, it's now appears to be a matter of when, rather than if.  Why is this important for investors?  There are 2 big reasons:

Businesses often need to borrow money for expansion, and presently their interest costs for doing so are the lowest they've been in nearly 50 years. When interest rates finally start heading up, it will be more expensive, and thus less attractive, for businesses to borrow for expansion. That has negative implications for shareholder profits.

The other reason is that bond holders are very much affected by the level of interest rates. If you currently own a 30 year bond from 2014 that is paying 3%, and the same company borrows more money this year, but has to pay 3.5% interest on the new borrowing,  that means the bondholder with 29 years left on their purchase is earning 14% less interest per year than a buyer of the new 30 year bond. This results in the price at which the older bond can be sold going down.

Give me a call or send an email to schedule a time to talk about how these issues could affect you.