There has been a growing fear in recent years that we may soon, “finally” face a rising interest rate environment again for the first time in over 30 years. While the catalyst to trigger such a rate increase is uncertain – first it was anticipated with rising inflation due to the Fed’s QE policies, and now it’s expected as a result of the tapering that slowly ends them – it’s hard to argue against the view that from a long-term perspective, rates are likely to be higher at some point in the future.
While the ramifications are quite straightforward – and not very good! – for bond prices, and at least raise concerns for other asset classes like stocks and real estate, it’s notable that there are also many ‘secondary’ impacts of rising rates that are equally notable for financial planning purposes. In fact, for many clients, the most profound impacts of rising rates may be the planning issues most clients are not even thinking about right now!
For instance, while higher rates are negative for retail bond investors, it can be very good news for insurance companies, who invest the overwhelming majority of their assets into bonds that match their liabilities. With higher rates, insurance companies need less in premiums to secure the requisite cash flows for their future claims, potentially providing much needed relief to the premium pricing pressure on everything from long-term care insurance to secondary guarantee universal life policies. On the other hand, higher interest rates are also higher discount rates for other strategies, which can reduce the value of everything from a pension lump sum, to the benefit of delaying Social Security, to the borrowing limits on a reverse mortgage. On the other hand, the sustainability of safe withdrawal rates may be improved!
Perhaps the most significant shift with higher rates, though, will simply be the fact that once again, “cash” will actually pay something. For companies that offer money market funds – including the major RIA custodians – this represents a potentially significant financial boon, as rates rise to the point where companies don’t have to subsidize and can actually profit from their money market offerings. Yet given how much easier it is to now manage “cash” electronically, from a mobile device, and move money across accounts or even financial institutions to seek out a better yield, the coming rise in interest rates may open up a whole new world of “digital cash management” as well!