Smart Moves for Tomorrow's Higher Interest Rates
Luke Mullins and Rob Silverblatt
Although the economic crisis has gutted home values and sent unemployment surging, not all of its outcomes have disadvantaged consumers. As the financial system imploded in late 2008, yields on 10-year treasury notes -- a key benchmark for longer-term interest rates -- fell to an average of 2.18 percent for the last week in December. That was the lowest level in nearly 50 years, according to HSH.com. Although yields have since bounced back, a number of forces have converged to keep them at historically depressed levels: The slack in the American economy has overwhelmed inflation concerns. Periodic bouts of fear -- most recently surrounding Greek debt -- have driven inventors to the safety of low-risk investments, like U.S. treasuries. Meanwhile, the Federal Reserve has slashed its benchmark interest rate to as low as zero while launching a program to buy up hundreds of billions of dollars in long-term treasuries.
For the week ending
The trend is linked to the economic recovery. The Fed has already ended its purchases of treasuries and is expected to slowly begin raising interest rates around the end of the year. The improving economy, meanwhile, will revive concerns about inflation and bolster loan demand. "We are looking at increased demand for credit, and that will drive up interest rates," DeKaser says. At the same time, massive federal budget deficits mean that Uncle Sam will continue to issue vast quantities of debt. But as the global recovery opens up new money-making avenues, treasury yields may have to increase to attract investors. "The fact is we are going to be continuing to flood the world with debt," says
How high will rates go? DeKaser projects 10-year treasury yields to finish 2010 at just under 4 percent, before rising to 5.24 percent at the end of 2011 and 5.56 percent at the end of 2012. Here is a look at seven moves consumers can make ahead of the upcoming rate increases:
1. Buy a home.
Since fixed-mortgage rates typically track 10-year treasury yields, home loan costs have been extremely attractive recently. Thirty-year fixed mortgage rates averaged 5.15 percent in the week ending
2. Refinance your mortgage.
At the same time, any homeowner who can benefit from the lower mortgage rates -- but hasn't done so already -- should consider refinancing their home loan. "The consensus is [mortgage rates] have bottomed out," says
3. Tweak your bond portfolio.
Most investors will find that their bond holdings are the most vulnerable parts of their portfolios during periods of rising interest rates. That's because increasing rates translate into lower bond prices. Still, there are ways investors can plan ahead. One of the more basic things to remember is that bonds with shorter durations are less sensitive to rate hikes. If you feel that higher interest rates are imminent, then "the first thing you would do is to reduce your [average] duration," says
4. Float to safety.
Another option is for investors to put a piece of their portfolios in floating-rate mutual funds. These funds can act as a shield since the amount they pay out to investors resets periodically. If rates increase, so do payouts. "When rates go up, your income goes up with them because your coupon will reset," says
5. Start thinking about inflation.
Long-term interest rates often go up when investors are worried that inflation is looming. At the moment, it's unclear how much of an issue inflation will be over the next few years, but given the government's ballooning deficit, it's a subject that is at least worth considering. Investors who are worried about inflation can find refuge in a number of investments, such as
6. Some more exotic options.
For aggressive investors, there are some ways to actively cash in on rising rates. Two common examples are shorting bonds and investing in inverse bond funds. In both instances, investors are rewarded if bond prices fall (which will happen when interest rates spike). Still, these are risky bets that require precise timing, and investors often make them for the wrong reasons. "People sometimes pick up these instruments because they're guided by emotion rather than rational arguments," says Tjornehoj.
7. Pay off credit card debt.
For cash-strapped Americans who are struggling to pay down credit card debts, things could get worse as interest rates creep up. "As longer-term interest rates go up, issuers will take that into account," says
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Smart Moves for Tomorrow's Higher Interest Rates
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