When Interest Rates Rise

By Nathan Welch

WHEN INTEREST RATES RISE
Personal Finance is completely different this time, when compared to the previous 34 years! The interest rate trend has changed and will have profound effects that are different from the conditioning that has occurred over decades. Will you choose to see it? This book details what to expect and how to reduce interest rate risk with bonds, mortgages, and outlines a prediction mechanism for equity markets.

• Language: English
• Publisher: BookBaby
• Release date: Jan 5, 2019
• ISBN: 9781543959529

Book preview

When Interest Rates Rise

Personal Finance is completely different this time, when compared to the previous 34 years! The interest rate trend has changed and will have profound effects that are different from the conditioning that has occurred over decades. Will you choose to see it? This book details what to expect and how to reduce interest rate risk with bonds, mortgages, and outlines a prediction mechanism for equity markets.

Nathan Welch

All Rights Reserved

First Published in 2019

ISBN 9781543959529

The right of Nathan Welch to be identified as the author of this work has been asserted by them in accordance with the Copyright, Designs and Patents Act 1988.

All rights reserved.  No part of this publication may be reproduced, stored in or introduced into a retrieval system, or transmitted, in any form, or by any means (electronic, mechanical, photocopying, recording, or otherwise) without the prior written permission of the author.  Any person who does any unauthorized act in relation to this publication may be liable to criminal prosecution and civil claims for damages.

Contents

Introduction       Setting The Stage

Chapter 1:       Real World Impacts To Personal Finance

Chapter 2:       Why Interest Rates?

Chapter 3:       Interest Rate Risk A Silent Wealth Killer

Chapter 4:       Inflation’s Link To Interest Rates

Chapter 5:       Likely More Powerful Than The President

Chapter 6:       Interest Rate Anguish, The Beginning To Unusual Times

Chapter 7:       Dotcom, Housing Values, And Interest Rates

Chapter 8:       The Beginning To The End… Mortgages

Chapter 9:       Financial Engineering That Devastated Families and Resulted In Artificial Interest Rates

Chapter 10:       The Fall Of The Banking Titans

Chapter 11:       Great Recession: Unemployment, Underemployment

Chapter 12:       Scrambling Of The Jets: Quantitative Easing, The Sonic Boom

Chapter 13:       The Unwind Of Quantitative Easing

Chapter 14:       Interest Rates The Silent Variable To A Payment

Chapter 15:       Why The Track Record For Home Values Has Been So Good

Chapter 16:       Home Values Flat To Decreasing

Chapter 17:      Interest Rates Drop Then Stay Flat: What Did Bonds Due?

Chapter 18:       National Debt And Impact On Buyers Of Bonds

Chapter 19:       Bonds And Fixed Income When Interest Rates Rise

Chapter 20:       What To Do With Bond Funds When Interest Rates Rise

Chapter 21:       Where To Store Cash

Chapter 22:       The Eighth Wonder Of The World… Congratulations You Can See It!

When Interest Rates Rise

Introduction

Setting The Stage

The title says it all, in a recent October 2018 article, Bonds in $916 Billion Wipeout, Spark Fear of Worst Run Since 1976, by Bloomberg. This has taken a few by surprise.  Most people don’t even know that their bond and fixed income investments are losing value. What if I told you we knew this was going to occur, three years ago!  How frustrating!

Personal finance requires us to understand interest rates on all levels.  Specifically, how they affect all income streams that we will get in retirement.  Interest rates will also have an effect on the investments we own.  A change in the interest rate will cause a change in value of the investment product we purchased, up or down, including your home.

Understanding how interest rates interact with personal finance will be a key determinant to how you navigate debt and generate wealth.  Our journey will take a look backward, at key events that created what I will call, Artificial Interest Rates, and how we can use this information to help prevent financial loss or be used to generate gains for ourselves and our loved ones.

At the end of this book you will understand how interest rates are determined and how they move, giving you advantages to all aspects of personal finance.  Additionally, there will be personal finance tips, relative to interest rates that you can act upon. In short, you will never again look at interest rates in the same way.

Chapter 1

Real Impacts To Personal Finance

This book will begin by setting the stage with real personal scenarios.  Each of these scenarios are not unique.  They are common with millions of people across the country.  Their lives where changed by what most consider a silent insignificant variable.  We will learn that interest rates are anything but silent and insignificant.

It was dark, but the stars were clearly lighting up the night sky, a common night in midwestern Iowa. Nick, 30 years old, was just getting home from his second job. His wife Jessica was at home, asleep, along with their one year old and another baby on the way.  He grabbed the mail as he pulled in the driveway.  Once inside, he ran through the pile of junk mail to find a letter from their mortgage company. 

It was those junk-like envelopes.  When you get one you know it’s a bill.  This time it wasn’t a bill, rather a notice that their interest rate had just gone up on their mortgage. Their payment was going up.  Aren’t those locked, he thought to himself?  They couldn’t afford to pay more, he was already working two jobs to stay afloat for his family.  Sick to his stomach, he was unsure if he should wake his wife to deliver the bad news or just stew on it until morning.

Across the country, Michael, 45 years old, who lived in one of those sky view condos in NYC was getting a similar letter. He had just gotten home from a dinner party with friends. He had a great sales job and drove a fancy car but still lived life through payments. His interest rate on his Home Equity Line of Credit (HELOC) was going up.  He took this out to put money down on his second home in Aspen, Colorado.

Michael was confused and frustrated.  This was because he obtained this HELOC over four years ago.  Prior to that interest rates had never changed.  Why are they changing, a clear mistake?  That evening would be spent looking for the loan documents that he signed.

Michael’s mom, Betsy, 72 years old, lived in the foot hills of Aspen.  She was a four-foot, ten-inch spit fire of a lady who was there taking advantage of the new laws around certain medicinal products, if you know what I mean.  She had no debt, and plenty of passive income to live. 

Her financial planner had her well diversified in equities and fixed income investments.  Betsy would visit with her financial planner every year and soon they would be having their annual meeting.  She was thinking about making him some special brownies!

The connections between Nick, Michael and Betsy will become clear as we move along.  You will see what happened to their lives, the force of the interest rate was there whether or not they choose to see it.  The effects are there, subtle, slowly changing, but there.  It will be your choice whether you learn to see it or not. 

Interest rates will always inflict an effect on your personal finances.  Understanding them, their history, and how they change investment values and your life are the purpose for this book.

Chapter 2

Why Interest Rates?

Why interest rates?  The impact from interest rates has never before been so important to personal finance, for your wealth generation and wealth preservation.  If the housing and financial crisis were not enough to scare you, well there is another chapter to this story.  Unprecedented events have occurred that have created mindsets that may not be suited for what is to come and what will be. 

A rising interest rate will have profound effects on fixed income markets and major points within personal finance.  It is knowledge on interest rates that will keep your outcome different from that of Nick, Michael, or Betsy.  Their life stories will be at the mercy of interest rates effects. 

The group, that is Nick, Michael, and Betsy, never had interest rate discussions when personal finance conversations occurred.  When reflecting back at conversations with financial planners, friends, and family, if interest rates were discussed, it was only about their current level.  There was no discussion on longer term trends and impacts to their life of finances.  Their life lessons will help you look at interest rates from a different perspective and give you the knowledge to process information differently.  No one is more concerned about you, than you.  Definitely an egoism perspective here, but a real one. 

Michael was an avid Nicholas Cage fan.  He was a big enough spender to have scored a few autographed pictures of Nicholas Cage, which were present on the entrance to his home theater.  We will later find out, but there is a little irony with this, as Nicholas Cage, fell asleep with his personal finances and eroded his wealth.  You could erode your wealth, unknowingly, like Nicholas Cage if interest rates are not considered in your personal financial planning. The goal here is to grow and protect your hard-earned money and not have it vanish.

Here is the story on Nicolas Cage.  He made a fortune from the movies like, Gone in 60 Seconds and National Treasure.  From 1996 to 2011 Nicolas Cage would earn over $150 million dollars.  Lavish spending and no oversight or accountability to his financial managers cost him to lose all that money and owe the IRS millions of dollars.  A lot of people would get caught in bad economic times and experience wealth or financial hardship from lack of awareness.  Celebrities would get got caught too, Nicolas Cage purchased a 28-room castle which sits on 395 acres of forest in 2007.  Talk about a money pit and bad timing, no pun intended.

Most of us will never have that kind of money but we can do a much better job hanging on to our money and investing it.  Debt avoidance and capital preservation are key concepts to personal finance.  Betsy had no debt and before retiring, she had her home paid off in full.  Financial freedom is what Betsy had, no debts, and a livable stream of money from her investments. 

The entire group, Nick, Mike, and Betsy, all had perceptions of personal finance that were formed due to a long trend in the interest rate.  Little focus is spent on the trend of the interest rate as it moves very quietly over all aspects of personal finance.  For example, how often do you look at stock tickers or your investment account balances… in a day, a week, a month?  You most certainly are looking at your investment account balances more times than you are looking at interest rates, let alone changes in interest rates from a previous point, or historical trend.

Even though we don’t spend as much, if any, time looking at interest rates, we know that interest rates have an effect on all investments and are a component variable in all loan types.  Sometimes interest rates are not viewed as something that may change.  This is because interest rates generally change slowly and people view them as something they cannot control.  This results in most dismissing their importance or impact to personal finance.

Take for example, when Michael purchased his BMW M3 series.  It wasn’t the interest rate that Michael was looking at, it was the payment.  Simply, could he afford the monthly payment?  Most people, including Michael, that have a car loan, will not be able to tell you the interest rate on their loan.

Most people don’t dissect a payment into principal and interest.  The interest rate really only becomes visible to the buyer when there is an interest rate change.  An example of this would be if Michael went to the car dealer today to price out his M3 with options.  He would think about these options and return a few weeks later.  To his disbelief, the monthly payment was increased by $30 dollars from what he was originally quoted.  The dealer would tell Michael that the interest rate had changed.

As you can see, it wasn’t the size of the interest rate that was impactful, rather it is the speed at which the interest rate changed, that would get his attention. Meaning we often don’t pay attention to the interest rate unless its alarmingly different at the point of transaction, for the better or worse. 

Take Nick for example, he was only concerned with the change in the mortgage payment, not necessarily why.  The root cause of the payment change, that is the interest rate, still isn’t a variable that Nick is conditioned to look at.

When interest rates are lowering, from a loan perspective, the effects of interest rate change often go unnoticed.  This is because the next time a loan resets or a new loan is obtained, the interest rate terms are always better. 

Let’s take a different perspective, that’s from the position of receiving interest versus paying it.  When interest rates are lowering, you will get a little less income from your investments than you would at higher interest rates. This is often tolerated because the value of the asset is increasing.

This is the exact case for Betsy.  She would have all interest deposited direct into her checking account.  She was most aware that her income is lower than what she had gotten in the past but was accepting of this because her investment account was growing.  At the moment, she isn’t aware that these effects are due to the interest rate.

The benefits we have seen from long durations of consecutive interest rate decreases has shaped the way we look at personal finance.  In short, it has caused Nick, Michael, and Betsy to grow complacent.  Just like through time, a house cat loses the skill of hunting and interpreting the environment around them.  These lower interest rates we have experienced are not from normal market forces, albeit from unlikely events.  Nonetheless, prolonged lowering of interest rates may cause us to make drastic mistakes within our decisions in all aspects of personal finance.  These mistakes are based on real learned assumptions that are likely to never occur again in our lifetimes.  Nick, Michael, and Betsy are all catastrophes from this conditioning.

We must understand that changing interest rates are not a bad thing.  They are constantly changing, what makes the changes good depends on how you are positioned or exposed. Nick, Michael, and Betsy could have prevented their personal finance outcomes, provided they had awareness around interest rates.  It is like a fire, useful and beneficial, but when certain elements occur, like high wind, lighter fluid, or some dried out pine needles, something useful can end up burning a city to the ground.  Understanding interest rates and their movements will help you look at interest rates like a campfire and avoid a forest fire.

When we talked about long trends in lowering interest rates, it is actually surprising that it was 34 years in length.  That’s correct, 34 years of lowering interest rates.  There is a learned perspective that occurs over the course of 34 years.  Over this length of time, it is only logical that you may view certain investments moving in a direction by a force that is something other than a reflection of interest rate changes.  Nick, Michael, and Betsy all fell into this trap of conditioning. Betsy truly believes that her bond fund only goes up in value.  She believes this because she has seen it and lived it.  Everything goes up in value through time, right? Wrong.

Considering that most scholars on topic of habit formation say that it takes anywhere from 21 days to 6 months to convert something to habit.  It may be logical that it takes relatively the same length to form assumptions based on past performance.  Thus, we can all agree that over the course of 34 years some assumptions would have made their way to hard fact.  The key wording here is that a trend is not a fact but rather a temporary state, that could eventually change.  If you were paying attention to housing during the years prior to the burst in 2007, you may remember some not so key advice that you likely received.

Nick was at a friend’s house watching the Superbowl.  This was the kind of gathering where there were friends of friends.  Early in the night he ran into a distinguished looking, wealthy, well-spoken guy.  Nick always enjoyed talking with accomplished wealthy people, as he wanted to be like them someday.  Nick would like to mention, that is admit,