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What boomers need to do about tomorrow's higher interest rates
A Baby Boomer's Perspective on Higher Interest Rates
by Gary Foreman
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If you're a baby boomer you've seen your share of interest rate changes over the years. We were raised in an era where a passbook (with a real pocket-sized book listing deposits and withdrawals) earned you a whopping 3%. We also saw mortgages in the 12%+ range during the late 70's and early 80's. Now we're seeing CD rates of 1 and 2%, so it shouldn't be any surprise to us that interest rates will continue to change. In fact, shame on us if we ignore history and assume that rates will continue to stay at this level for the indefinite future.
But which way will they go? And will they move very far?
Lots of experts are trying to answer those two questions. I think that two facts and a little common sense can give us a pretty good feel for what the future might bring.
There are two reasons why I'm pretty sure that interest rates will rise. Perhaps not more than a percent or so, but still higher than they are today.
First, the experts are predicting that the G7 governments will need to borrow $8 trillion during the next year. And they think that between the amount that they're borrowing and their newly lowered credit ratings that cost to borrow will increase nearly 40% (source: Bloomberg).
Second, the American consumer seems to be pulling out his credit card again. For the last three years we've been paying off consumer debt. But it appears that consumer spending is beginning to grow again. Economists are predicting 2 to 3% growth in the economy in 2013. Most of that growth will come from consumers. Since the average consumer isn't getting raises in this economy the only way that they can spend more is to borrow more.
Combined that means that there will be a greater demand for borrowed money in 2013. We all know that increased demand without increased supply means a higher price. In this case the higher price is a higher interest rate.
The Federal Reserve and central banks are trying to keep rates down worldwide. But that's not easy in this environment. If rates are too low people with money won't lend to governments or other individuals.
The alternative for governments is to increase the supply of money by printing more of it. But, that would cause inflation. And, since we all remember the 70's we know that means higher interest rates.
Bottom line? I'd expect rates to increase a bit over the next 12 months.
So what's an aware boomer to do? First, get rid of any variable rate debt. Think credit cards, credit lines against your house or any other loan where they can increase the rates without your permission.
Pay them off if possible. If not, consider shifting loans to fixed instruments (like your home mortgage).
The key is to not be in a position where the interest payments on your loans can go up each month if rates rise.
On the flip side, protect your investments and retirement accounts. Loaning money for long periods of time at today's rates is foolish. I was a financial planner in the 80's. Frequently I had people come in with corporate and municipal bonds that were paying a fraction of the high rates of the day. They were willing to sell the bonds until they found out that they were only worth about half of the face amount. The only way to get the full value out was to wait until they matured, a decade or more in the future.
What happened? They committed to loaning money at 5 or 6% for 20 or 30 years. New bonds were offering 2 or 3 times that interest rate. So no one would buy their bonds unless they were deeply discounted.
Now is the time to check your investments and retirement accounts to make sure you're not in a position to fall into the same trap. Sure, if you can get an extra percent on a 3 year over a 12 month CD you should take it. But, don't commit to long time frames at today's rates.
And, if you have long-term bonds consider getting rid of them. That goes for the zero coupon bonds that will mature later on. They're often found in retirement accounts as 'target 20xx' bonds or funds. Talk with your broker or financial planner if you're unsure what you own.
Boomers have an advantage. We've lived through both very high and very low interest rates. We've seen enough to know that current rates won't last forever. And, hopefully, we're smart enough to be prepared when rates start to rise.
updated March, 2013
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Gary Foreman is a former financial planner and purchasing manager who currently edits The Dollar Stretcher.com website and newsletters. He's been featured in MSN Money, Yahoo Finance, Fox Business, The Nightly Business Report and he's a regular contributor to US News Money and CreditCards.com. You can follow Gary on Twitter or visit Gary Foreman on Google+. |
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