Do you remember the spring of 2021? It felt like we had all been let out of COVID-19 jail. Sure, there were new variants of the virus, but most people were vaccinated and eager to swipe, tap or hand over cash.
We promptly took our then-3-year-old to Jamaica. This was the inflation liftoff.
An eagerness to spend, a money supply that was about 30% higher than pre-pandemic levels and supply shortages from shuttered factories quickly caused prices to accelerate.
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If you’d told me then that I would still be writing about inflation five years later, I would have been seriously concerned. But here we are.
We have now been through what most consider an interest rate-cutting cycle that was cut short. We also have a new Federal Reserve chair, Kevin Warsh, who has been (not so) tacitly tasked with cutting rates at the same time inflation has reawakened.
The two things are at odds: Raising rates is supposed to cool inflation by making things more expensive, while cutting rates is stimulative to the economy and often inflationary.
The majority of this inflation is headline inflation (food and energy), caused by the oil shock in Iran. Because of this, the market had moved from a less than 1% chance of a rate hike at the beginning of 2026 to an almost 45% chance as of mid-May.
Indeed, in September, the Fed raised the federal funds rate by 25 basis points, to 3.75% to 4%. The Fed is expected to raise the rate again before the end of the year.
So, here’s what that means for retired folks.
A bounce back in cash rates
It doesn’t seem that long ago when cash was paying basically nothing. More recently, you could get cash equivalents over 5% in a high-yield savings account.
Today, most things have settled in the mid-3% range. In the 5% range, it was a pretty easy decision for retirees who needed liquidity to keep it in cash.
In the 3% range, it’s a tougher question. That question is a bit easier to answer now that the Fed has hiked rates.
If you still have a lot of cash sitting in a checking account at a large bank, there is probably a better way.
Most brokerage houses have a plethora of cash-equivalent options that pay significantly more.
Good for guaranteed income
Similar to cash equivalents, guaranteed income in the form of fixed annuities tends to move up with interest rates. The higher the rate environment, the more an insurance company is willing to pay you for the same pot of money you turn over to them.
In the previous hiking cycle, we were able to replace the majority of our clients’ annuities with higher income guarantees — often significantly higher.
If you have an annuity issued between 2000 and 2022, it’s worth having it looked at.
Time to de-leverage
When rates rise, floating-rate loans become more expensive.
For our clients, floating-rate loans most often take the form of home equity lines, securities-backed lines of credit and adjustable-rate mortgages. If you have floating-rate debt and some money in the bank, it may be a good time to pay down those debts.
My wife’s car lease ended in 2022, and we were quoted rates of 9% or more for five-year car notes. Though it shouldn’t be anything like last time, this is a strong argument for buying vehicles in cash should the funds be available.
I often use 5% as a sort of back-of-the-envelope line in the sand. If the note is over 5% and you have the cash, you probably want to do that. Below 5% and financing likely makes sense.
Your financial plan should dictate this decision. In our software, we can raise the rate and then see what happens to the plan success rate if a client were to accelerate the paydown. You can play around with that same software for free.
Continued struggles in the broader housing market
If you were waiting for mortgage rates to come down to bring more buyers into the pool for your home, you’ll either have to keep waiting or pull off the Band-Aid and sell.
Nationally, the housing market is struggling. There are many more sellers than buyers. It’s the opposite of the insane environment coming out of the pandemic.
However, real estate is hyperlocal, and we have clients who are selling their homes with little issue.
Zooming out, higher rates are bad for the housing market. Buyers focus on what they can afford in a monthly payment more than the total price.
As interest expense goes up, that same monthly payment buys less, which should bring down housing prices.
It’s good for buying, but not so good for selling.
How you can help your kids if they’re trying to buy a home
Just as the pool of buyers for your property is now reconsidering a purchase, your adult children who are trying to get into the market are probably equally frustrated.
In 2022, someone who took on a $1 million, 3% mortgage was paying $2,500 per month in interest expense. Today, that same loan amount at 6.5% has a monthly interest expense of about $5,400. That’s $2,900 more per month for the same loan amount.
There are a lot of factors to consider before writing a large check to your kids to help them buy a home.
Here are a few to keep in mind for intrafamily loans:
- The loan must not materially impact your situation: While this is a secured loan and you could take ownership of the home should they default, that is an ugly situation. Lend only money you know you don’t need.
- This is an actual loan, not a gift: Interest must be charged at a minimum federal rate, which can be referenced at the IRS website.
- Lending money can make Thanksgiving dinner uncomfortable: This isn’t just a math problem. You have to accept that you are signing up for a long-term financial arrangement within your family. For some, that’s a plus; for others, it’s a red line.
If the stars align, these loan rates will be lower than what your kids could get in the market, and the interest you earn will typically be higher than what you’re earning at the bank.