We’ve all felt inflation this year – in a way that we haven’t in a long time. As part of its mandate to keep prices stable, the Federal Reserve has been steadily raising interest rates all year. To most of us, the effects of rising interest rates show up most in the housing markets – mortgages have certainly become more expensive this year!
However, rising interest rates can affect your retirement beyond just housing. Here are five ways that rising rates may affect your retirement plan. And be sure to read until the very end where I discuss the big one: your investments.
1. Credit Cards.
More and more people in the U.S. have started leaning on their credit cards to make ends meet. Unfortunately, rising interest rates also mean that borrowing costs for credit card holders are going up too.
If you carry a balance on your cards – or perhaps occasionally use one to carry unexpected expenses – your monthly interest costs will be increasing as rates go up. Rates are at record highs, with the average rate coming in at 19.04% recently.
When we think about credit card rates in the larger economic picture, we see that Americans’ revolving debt continues to hit new all-time highs, albeit at a slowing rate. This tends to suggest that U.S. consumers are starting to tap out. This will certainly cool demand, especially as borrowing costs rise.
Rising interest rates will also increase borrowing costs for HELOCs. Over the years, a financial planning “hack” has been to set up a HELOC in lieu of a traditional emergency fund. After all, it’s a lower interest rate option than credit cards, plus it’s secured by an asset. It’s not a bad strategy.
However, rising interest rates will increase the borrowing costs associated with HELOCs. So, that emergency “fund” could become much more expensive to maintain.
Also, let’s not forget that banks closed out HELOCs with a zero balance during the financial crisis. So, this strategy isn’t foolproof.
Another way that rising interest rates will affect your retirement is housing costs. We all know that mortgages are much more expensive than they were even a year ago. In some cases, they have forced some potential buyers out of the market entirely.
If downsizing to a new home before or during retirement is part of your plan, then higher rates will increase your borrowing costs. Hopefully, you won’t need to get a mortgage as part of your downsizing. Rising mortgage rates have already cooled the housing market significantly this year, and there may still be further drops in prices to come.
4. Car Loans.
Unfortunately, cars wear out! I had to say goodbye to the Beluga, to my old SUV, earlier this year. If you’ll need to replace cars in retirement – and can’t pay with cash – then these purchases will become much more expensive.
There’s one thing to note here with all of these expenses. Whether it’s a mortgage, credit card interest, HELOC interest, or a car note, these are all recurring expenses. Recurring expenses are the number one factor that can make or break your chances of a successful retirement.
If you’re not debt-free, rising interest rates will undoubtedly create additional stress on your retirement.
5. Retirement Portfolios.
Until now, the effects of rising interest rates are fairly straightforward. However, they do impact your investments as well, and not necessarily for the better.
Rising interest rates have a direct effect on the bonds in your portfolio. Bond values move in the opposite direction of interest rates – this is called “interest rate risk”. As rates rise, bonds decline in value, as we’ve seen this year. I’m not sure that everyone appreciated how much the “safe” investments in your portfolio could drop in such a short time!
That’s why it’s important to choose bonds with shorter “durations”. The shorter the duration, the less they will be affected by interest rate movements.
The silver lining for bonds is that investors will finally start seeing some yield.
While bonds are simple enough, rising interest rates affect stocks in multiple ways. First, the companies you’re investing in will now have higher borrowing costs, just like the rest of us, compressing their margins.
The costs of inputs for these companies have increased with inflation, too. Not only have the cost of goods sold increased, but labor and salaries have also gone up. Current low unemployment (for the moment), has driven up labor costs.
All of this points to a more challenging environment for most companies to be successful. Lower expected profits and dividends would naturally lead to lower stock prices.
As retirement portfolios feel the effects of rising interest rates, we might see our sustainable retirement withdrawals get cut. Remember that sequence risk – the order of investment returns that you actually see in the first few years of retirement – will affect how much you can pay yourself later in life. Even if the average return is the same, the order still matters.
While inflation isn’t doing us any favors, we can still do our best to manage it. I don’t expect that we’ll continue to see raging inflation like this for years and years. At some point, the pain will be too great, and demand will completely dry up.
And that’s the point of all this. If one of the Fed’s mandates is for price stability, the big lever they have to pull in order to tame inflation is raising rates. Higher rates squelch demand.
So, when pundits and politicians bleat about the Fed killing the economy by raising rates, they’re right. That’s pretty much the only option the Fed has.
If you need help protecting your retirement from inflation, then click here to set up a quick, complimentary introduction call to see if Prana Wealth is a good fit. We do still have the capacity to take on new clients.
As a fee-only financial advisor in Atlanta, we can (and do) work virtually with clients all across the U.S. and we’re here to help you when you’re ready.