Increasingly vocal critics say Federal Reserve efforts to stimulate the economy will ultimately hamper growth by creating spiraling inflation and interest rates. Chairman Ben Bernanke is holding the course and defends the Fed’s action as necessary to bolster the weak job market.
Regardless of the ultimate effects of the government’s Quantitative Easing program, investors can expect interest rates to rise as the nation continues to recover from the Recession. Rising interest rates are historically associated with economic growth.
An old adage tells us that “high interest rates are good for savers and bad for borrowers.” Investors can use this conventional wisdom to prepare a strategy that defends against the downside and capitalizes on the upside of higher interest rates.
Borrowers may want to evaluate the types of credit and loans they use to see if they offer the best protection from rising interest rates. Typically, long-term, fixed-rate loans offer the best defense. Borrowers expecting a rise in interest rates can calculate the pros and cons of refinancing debt that comes with variable rates. Debt-consolidation may also offer protection from rising credit-card rates.
Savers anticipating higher rates might employ a strategy known as laddering. The system provides security, yet still allows investors to take advantage of rising rates. Investors who ladder the cash in their portfolio buy products such as CDs with due dates that stretch into the future. CDs laddered to mature in three, six, nine and 12 months, for example, rollover at higher rates when interest goes up. Investors can also ladder fixed-income investments to become due at a time they want to use the cash.
The Fed has controlled short-term interest rates by keeping its short-term rate near zero for the past two-years, but long-term interest rates, which are beyond the Fed’s direct control, are on the rise. This increase, as well as higher lending costs for mortgages and credit cards, have helped fuel fears of inflation and rising interest rates. The fear, alone, can affect consumer behavior.
Inflation ranks among the top concerns of mass affluent investors, who have a net worth of $500,000 to $1 million, not including primary residence. Wealthier investors worry more about the national debt.