Investing and the 800-Pound Gorilla - Future Interest Rates
March 31st, 2009 |In late 2008 and early 2009 investors did not know how to invest to make money. There appeared to be no good investing strategies, only a place to hide. The lucky folks hid in cash equivalents (cash) like T-bills and money market funds, or in savings products like CD’s and savings bonds. Interest rates were at historial lows. Hiding in cash was not a good way to make money, but at least you didn’t lose money.
Picture a conference room full of investors trying to come up with investing strategies for how to invest to make money in such a financial environment. The stock market was down 50%, bond yields were low, commodities prices were falling, and interest rates were at record lows.
Now picture ignoring the 800-pound gorilla in the room, the possibility that interest rates could rise in the not-too-distant future. In devising investing strategies and determining how to invest, interest rate trends can not be ignored. For the past 40 years interest rates have affected stock prices, bond values, and rates in the money markets and at the bank.
Consider these numbers for early 2009: federal funds rate near 0%, 1-year CD’s at about 1%, money market funds at .25%, and 30-year mortgages below 5%. How much lower can rates go before they turn around and head back up?
In deciding how to invest, the 800-pound gorilla really wants to know,”what happens when interest rates go up”? Here is what I have seen happen in the past, since I started in the investment business in 1972. When interest rates went up…
STOCKPRICESfell. Higher interest rates increase corporate borrowing costs. Sales fall as consumers who purchase on credit pull back on spending. Lower sales and higher costs translate to lower corporate profits and lower stock prices. Stock investors did not make money, they lost it.
BONDPRICES fell. As interest rates rise, existing bonds with lower coupon interest rates become less attractive. Investors bid bond prices down to bring yields up to prevailing rates. Bond investors did not make money, they lost it as well.
CASH (equivalents)and SAVINGSPRODUCTS paid higher rates. Cash, as they say in the business, wasking. When interest ratesgo up rates on CD’s, T-bills, savings accounts, andmoney market funds followsuit. So do rates for credit cards, mortgages, and other loans. Investors here did make money in the form of higher interest, and they avoided heavy losses.
Since 2 out of 3 of our investment areas were losers in the past when interest rates went up significantly, it might appear that the only sensible investing strategy when rates are rising is tobe 100% in cash or savings products. In the past, smart investors in search of how to invest to really make money have looked outside the box of stocks and bonds…to alternative investments.
ALTERNATIVEINVESTMENTS in my mind’s eye includes foreign securities, oil,gas, gold, silver, real estate,basic materials like copper and aluminum, and othertangibles.
How can the average investor participate in these markets? Usingoil as an example, you do not want to go out and buybarrels of oil or gasoline if you think oil prices will rise. Buying futurescontracts on crude oil isnot a suitable investing strategy for most folks, either. Ifyou havea brokerage account and know how to invest, youcan buy oil stocks or oil ETF’s(exchange traded funds).
Or you could participate and make money as oil prices rise the easy way. Simply invest in a specialty mutual fund,an energy fund that holds oil stocks. There are also mutual funds that specialize in gold stocks, foreign stocks, real estate stocks, and so on.
A retired financial planner, James Leitz has an MBA (finance) and 35 years of investing experience. For 20 years he advised individual investors, working directly with them helping them to reach their financial goals.
Jim is the author of a complete investor guide, Invest Informed, designed for average investors or would-be investors of all levels of financial background and experience.
To learn more about investments and investing and his new financial guide go to http://www.investinformed.com
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