What Is Your High-Interest Rate Financial Plan?

No matter where interest rates are, there are certain financial decisions you can make to put yourself in a better position to achieve your goals.

The Federal Funds Rate is sitting at 5.33% right now. It’s a 22-year high!

If you are using the same financial plan you had 5 years ago, you are likely missing out on some opportunity.

That’s why having a dynamic financial plan is so important…

Yesterday’s opportunities become today’s liabilities, and vice versa.

In light of the highest interest rates we are now experiencing after more than two decades, here are 3 things we recommend you consider:

1) Keep your short-term cash in an HYSA, CDs, Treasury Bills, or Money Market (we have a preference for high-income earners in certain states)

The % of your assets you should have in cash depends on a variety of factors, including your expenses, goals, and risk tolerance.

But interest rates are another big determining factor.

In low-interest rate environments, keeping less in cash is usually a wise move. However, with the Federal funds rate where it is today, many online banks are now offering High Yield Savings Accounts with rates over 4%.

If you don’t need that cash that you have sitting in your checking account for a while (more than 6 months to a year), but don’t want to place it in variable investments like equities or real estate, Certificates of Deposit offer similar rates of returns.?We are seeing rates in the 6-12 month term range from roughly 4-5%.

Another option is to invest in short-term treasury bills (1 year or less in maturity). These are considered the safest form of debt and are backed by the full faith and credit of the US government. For those in states that have an income tax (for example, California), the interest earned on your cash is only taxed at the Federal level, not at the state level.

Be mindful of the fees that you are paying in a HYSA, CD, or Money Market Fund. We have heard potential clients discuss how they are earning 5% in a Money Market fund, but come to find out there is an expense ratio of 0.5% and they are paying tax on the federal and state level for interest.

Despite these options, we talk to a lot of potential clients who are still keeping cash in old savings accounts paying 0.5% APY.

That’s excellent for the bank since they are earning the market rate on your cash, but not in your best interest.

2) Increase your savings rate

When interest rates are higher, two things tend to be true:?

• Prices are higher and the cost of borrowing becomes more expensive
• Cash earns a higher return than previously

Those are two reasons to consider spending less on unnecessary items and stashing that money away. Taking out a personal loan or putting purchases on a credit card without quickly paying it off can cause you to pay an egregious amount in interest over time. When rates are low, similar to what we experienced in 2020 and 2021, borrowing money most likely made more economic sense than today.

If you aren’t investing your cash, make sure you are at least setting the funds aside into a HYSA.

3) Revisit bonds

Bonds can be viewed as lower risk than stocks, as well as the potential for fixed, predictable income. Just because bonds didn’t make sense for you a few years ago doesn’t mean they may not now. However, not all bonds are considered "safe" or free of risk.

There is an inverse relationship between bond prices and interest rates. When interest rates rise, existing bond prices go down, and vice versa. The further you go out with maturity with your bonds (10-20+ years) the more sensitive the bond price is to interest rates going up or down.

We saw one of the fastest interest rate increases by the Federal Reserve in 2022. In turn, that put a substantial amount of pressure on existing bond prices and caused the worst year on record for the overall bond market. Banks like Silicon Valley Bank and First Republic went bankrupt due to investing in long-term bonds that had paper losses from rates rapidly rising. To fulfill client cash withdrawals, they had to sell and realize those bonds at massive losses.

Fortunately for our clients, we kept the maturity very short-term for our bonds through a short-term bond ladder, which had very little sensitivity to interest rates going up or down. In fact, we had a "negative duration" going into 2022 since we had a small hedge position whereby we shorted (bet against) long-term bond prices. Consequently, that kept our maturity so short that we had a negative duration with maturities (the short position specifically), which benefited from bond prices dramatically dropping from the Fed raising rates. Our firm eked out a positive return for our bonds in 2022.

However, we are now in an environment where it may make sense to have exposure to short-, intermediate-, and/or long-term bonds within your portfolio. Even though the Fed is saying they do not plan on cutting interest rates soon, they are also not signaling any more rate increases. That means that they will most likely cut rates moving forward, which will benefit intermediate and long-term bond prices the most. The reason is that if you own longer-term bonds, once rates drop from the current levels, you are locking in higher yields for a "long time", which would increase the bond price.

By working with a comprehensive financial planner and wealth advisor, they will take a look at all areas of your finances to give recommendations on your cash position, in addition to your investment portfolio.

There are so many variables to a financial plan, and each of them gets impacted by interest rate changes. That is why we believe it is helpful to have an advisor who is being proactive in response to what’s happening in the world.

Too many “plans” get made once, then never touched again.

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