At first glance, the title of this piece seems rather silly; of course interest rates matter. They affect the availability and cost of borrowing money, mortgage rates and more. Unbeknownst to many investors, interest rates can have implications on several sectors, and even a direct impact on your retirement holdings.
Over the last few months, Federal Reserve Chairman Ben Bernanke has been hinting that interest rates may begin to rise in the near term. The term “interest rates” is very broad, but we are referring specifically to 30 year treasury rates, mortgage rates, prime rate, etc. When we are referring to one specific rate, we will make note of which one, but on the whole all interest rates tend to be correlated.
When interest rates begin to rise, investors and consumers who track those numbers will notice a bottom has been reached. Once a bottom has been spotted and a new trend identified, investors and consumers begin to adjust their actions accordingly. For example, if an individual is looking to purchase a new home and is quoted a 4% mortgage, but next month mortgage rates drop to 3.75%, they have no incentive to purchase. Contrarily, if rates go from 3.75% up to 4%, buyers will have an incentive to purchase in order to lock in lower rates. These savings can sometimes be in the hundreds or thousands of dollars.
Rising interest rates can also create a spark that ignites an economy’s GDP. For the same reason that home buyers will hold out for a bottom in mortgage rates, businesses will hold out for a bottom in lending rates in order to obtain the cheapest money possible. When companies begin to borrow money, even at rates as low as 4% or 5%, they will invest those funds in projects that will earn them more than 4% or 5%. These capital intensive projects typically involve hiring of new employees, be they full or part time. The resulting cycle operates as follows; banks lend money, adding to their earnings, while businesses use borrowed funds to earn more than the cost of borrowing, depositing gains at the bank, who can then take those funds and loan them out to other businesses looking to grow or expand. This flow of money can be very good for a struggling economy.
Rising interest rates can drastically impact investors’ retirement as well. Our opinions on bonds are no secret by this pint, as we have written time and again about the dangers that a rising interest rate environment can have on the bond market; rising yields mean falling bond prices, and bonds are traded intraday just as stocks are. Unfortunately, many investors may not realize that they are exposed to the bond market through their pension or various mutual funds that they own until it is far too late.
Recently we learned that PIMCO was experiencing record outflows from their flagship bond fund. While this is not great news for those invested in PIMCO, this can be good news for the economy. Since rates were at historic lows for such a prolonged period of time, investors were able to exit at the peak and take their gains elsewhere. Most investors who were able to see gains from PIMCO will not let their money sit in cash for too long; they will look for the next value buy and but their money back to work.
Rising interest rates can be good for you as an investor or bad for you, depending on your holdings. Without proper knowledge, it is impossible to make the right decision for your investments and your future, and we encourage all readers to keep an eye on the bond market and what it means for their personal holdings.