Save, Spend or Borrow? Optimizing Asset Management for Interest Rates
Investing Retirement Funding InsightsSave, Spend or Borrow? Optimizing Asset Management for Interest Rates
Topics: Cash Management, Fixed Income, Bonds, CDs, Refinancing
Key Takeaways:
- Be mindful of the interest rate you are getting on your idle cash – the average account gives you just $6 for every $10,000 deposited!
- Historically low interest rates suggest modest wealth-building effect from bond/fixed income/CDs for investors with longer time horizons and minimal income needs
- Borrowing or refinancing assets could help optimize your current Asset Management strategy
Interest rates are no doubt a seriously dull topic but it affects 1) emergency fund cash, 2) the bond allocation in your portfolio, and 3) your ability to borrow. In my opinion if I want to optimize my Asset Management for building wealth, I believe I’m likely better off today ignoring CDs (lending to the bank) and repositioning my asset base. This might mean strategic borrowing (refinancing or maybe business investment or real estate) rather than paying off debt early. Of course, this depends on individual preference and many factors such as risk tolerance, time horizon and your personal goals.
During “peak Covid” I wrote a couple very specific posts for what was happening at that time – one about taking advantage of the market pullback and one about finding cash in a time of need (which actually isn’t specific to Covid). In that initial post I highlighted two important topics: 1) stock market opportunities and 2) interest rates (today’s topic).
Most of you likely glossed over the discussion on interest rates and were instead focused (wisely) on the pullback in the market and subsequent opportunities (we’ve had a 40% rebound off the bottom). Looking at Morningstar’s Fair Value chart (below), we saw (extremely quickly) that stocks were nearly as undervalued as when the Financial Crisis of 2008-2009 hit! The Price/Fair Value reached 0.70 for the first time since then – over a decade. As of this writing stocks are back to fair value. This is exactly the opportunity I was talking about for those who raised cash in early 2020 (because the market was overvalued – red) and could have put it to use pretty quickly as the market became undervalued (green).
So as stock market potential stole the show in that post I thought it worthwhile to revisit how interest rates can impact your Asset Management strategy. This is obviously a very boring topic no one wants to think about it, but interest rates affect us all in terms of how much benefit we receive from our idle cash, our bond allocation and the amount of money we can borrow.
Before we get into the details:
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On a personal note
As we talk about saving, spending and borrowing, we’ve personally (and thankfully) had pretty minimal changes through “Covid.” We’ve saved a little less due to the decline in income but have been at least maintaining our savings rate (as a % of income). As for spending, we’ve spent less on gas and a few other things but probably more on the occasional food pick up to help support the local restaurants so that’s about even. As for borrowing, we continue to be on the lookout for the next opportunity to borrow at very low interest rates for the next 30 years in an asset that is backed up by cash flow (ideally 10% cash on cash returns and 15% IRR or better). We’re hoping to have a project very soon.
The Importance of Interest Rates
Savings Rate
Incredibly, America’s personal saving rate skyrocketed to 33% in April (check out the spike on the far right in the graph below) after generally trending between 6-8% for several years prior (excluding 13% in March). I’m a bit suspicious regarding the data, which uses the ratio of personal savings to disposable income. Particularly as U.S. unemployment reached a record of 14.7% that same month, so I’m curious what the next month will show.
So my question is where are people saving this money? This is where interest rates come in. The current average interest rate for savings accounts is 0.06%!! That means a year’s worth of interest is $6 for every $10,000 you have in deposits! OMG! Again you have to have a place for liquidity, but as your stashing cash you should still be able to find something that provides you some return (even if its just 1-1.5%) in higher yielding money market accounts that still provide you adequate access to cash.
On the topic of low interest rates, the reason rates are so low is the Federal Funds rate is now basically 0% - in an effort to boost the economy. Read that as the government saying, “spend your money, don’t save it.” As a kid in the 80’s (see the chart below) I was crushing it in my bank account making 8%. CD rates were better than that! I didn’t have a mortgage then, so I didn’t realize what was happening.
But my point here is that you should be more discerning in where your idle cash sits. Particularly as you’re saving 33% of it! Evaluate your options and see if you can do better. Again, no one is going to bother doing this for you. Before you lock up money for a longer-term (even more than 12 months), consider other options. Letting your CD rollover will likely cost you money (from inflation), and so for the foreseeable future, I am not using those instruments.
So, you can’t save for retirement effectively at banks or with CDs. The long decline in interest rates (see the long-term downward slope from 1980 to 2010) over 30 years created a bull market for fixed income/bonds (prices go higher as interest rates go lower). You could lock in long-term rates even as they were declining, and just keep receiving those higher interest payments for years. Plus the value of your bonds would be increasing.
While it is a bit more difficult now to manage for yield, I prefer minimal exposure to the traditional bond funds given their correlation to stocks is higher than I’d like. Plus, an S&P 500 index fund yields about 2% while the aggregate bond index yields 2.7% - just modestly higher and with minimal upside compared to the larger stocks. My strategy is driven by a higher than average risk tolerance and 30+ year time horizon, so to find better options I’m looking at preferred stock funds or possibly municipal bonds. In full disclosure I’m a stock guy, not a bond guy – my personal portfolio largely reflects that. Again each asset allocation is client specific.
Debt management
As I mentioned, low interest rates aren’t encouraging you to save – their prompting you to spend. I would actually say they’re encouraging you to borrow. So how can I optimize my asset portfolio through borrowing? While I think great long-term returns come from the stock market, I am not encouraging borrowing to invest in the stock market. Some do that. Not me. You have no control or oversight, and ultimately the process is designed to make you sell when your assets are underperforming.
Where we as consumers can benefit is through refinancing assets – perhaps your largest single asset, your primary residence. Rates remain attractive, and I’m sure home equity is at or near recent highs. The issue is what you do with that additional savings, or any cash you take out – I encourage to use it for the future.
The primary mortgage refinance is basically the opposite of paying off your mortgage early. If that’s something you feel compelled to do because of a specific goal like financial freedom, then I understand. However, I make the case against it in my post about NOT paying off your mortgage, because I think you need to at least consider your return on investment. As I mention, paying off a 3.5% mortgage is like assuming you can’t get a better return than 3.5% on your cash. And yes, with low interest rates, finding an adequate fixed income product (bond, CD, etc.) is increasingly difficult, but there are some other options.
But if your path toward Financial Independence requires early debt retirement, beware that your portfolio of bonds doesn’t provide the same yield it used to. As you assemble a reasonable portfolio, remember you need to hedge against inflation with stocks, commodities, real estate, etc.
In closing, I’m not personally concerned with eliminating all debt in my life, quite simply because interest rates are low enough that I feel confident I can find a better long-term return. That’s why I mentioned I’m actually looking for the next opportunity to borrow for the next 30 years. At a minimum, I encourage you to be cognizant of interest rates and how they impact your portfolio today in terms of 1) your emergency fund cash return, 2) your fixed income/bond/CD allocation (CDs, generally speaking, are not currently good instruments of wealth-building), and 3) your ability to borrow (for business investment, real estate or refinancing).
Please check out more popular/related blog posts:
Why Should I Use a Financial Advisor for Asset Management?
How Do I Get Out of Credit Card Debt and Start a Budget?
How Can Effective Asset Management Help Me Reach Financial Independence?
How Much Money Do I Need to Save for Retirement?
How Much Should I Save for College?
Best (Most Read) MHB Advisory Blogs of 2019!
As well as other more recent posts:
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If you or someone you know has any financial-related questions, I would love to have a conversation, so please feel free to reach out: matt@mhb-advisory.com.
And stay tuned for additional blog posts on retirement savings and other topics.
Best wishes on your financial path!
Matt
This post was created by Matt Beeby, the Founder of MHB Advisory Services. Matt has been working in Financial Services and investing in real estate since 2005, though his investment experience spans nearly two decades. He is a Christ follower, active in both his church and his neighborhood association. Matt enjoys sports and family time. Read more about Matt on his website bio.
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Sources:
https://www.morningstar.com/market-fair-value
https://fred.stlouisfed.org/series/PSAVERT
https://fred.stlouisfed.org/series/FEDFUNDS
Photos: https://unsplash.com
