Interest Rates: What’s the Connection to Your Portfolio?

When it comes to interest rates, one thing’s for certain: What goes down will eventually come up.

The federal funds rate — the rate on which short-term interest rates are based — has varied significantly over time. It’s a cycle of ups and downs that can affect your personal finances — your credit card rates, for example. But what about less familiar effects, like those that interest rate changes can have on your investments? Understanding the relationship between bonds, stocks, and interest rates could help you better cope with inevitable changes in our economy and your portfolio.

Bond Market Mechanics

Interest rates often fall in a weak economy and rise as it strengthens. As the economy gathers steam, companies experience higher costs (wages and materials) and they usually borrow money to grow. That’s where bond yields and prices enter the equation.

What is yield? It’s a measure of a bond’s return based on the price the investor paid for it and the interest the bond will pay. Falling interest rates usually result in declining yields. As rates spiral downward, businesses and governments “call” or redeem the existing bonds they’ve issued that carry higher interest rates, replacing them with new, lower-yielding bonds. Why? To save money. (A homeowner refinances his or her home at a lower mortgage rate for the same reason.)

Interest rate changes affect bond prices in the opposite way. Declining interest rates usually result in rising bond prices and vice versa — think of it as a seesaw relationship. What causes this change? When interest rates rise, investors flock to new bonds because of their higher yields. Therefore, owners of existing bonds reduce prices in an attempt to attract buyers.

Investors who hold on to bonds until maturity aren’t concerned with this seesaw relationship. But bond fund investors may see its effects over time.

Evaluating Equities

Interest rate changes can also affect stocks. For instance, in the short term, the stock market often declines in the midst of rising interest rates because companies must pay more to borrow money for expansion and capital improvements. Increasing rates often impact small companies more than large, well-established firms. That’s because they usually have less cash, shorter track records, and other limited resources that put them at higher risk. On the other hand, a drop in interest rates may result in higher stock prices if corporate profits increase.

So why do some stocks increase in value even as interest rates rise, or vice versa? Because industry or company-specific factors — such as the development of a new product — can impact stock prices more than rate changes.

Taking Action

Is there anything an investor can do when faced with interest rate uncertainty? You bet. Although you can’t change interest rates, you can assemble a portfolio that can potentially ride out the inevitable ups and downs. Risk reduction begins with diversifying your investments in as many ways as possible.

Let’s start with equities. Consider investing across different sectors, because no one knows which of today’s industries will fuel the next expansion. Also be aware that some sectors — such as energy — are more economically sensitive than others, which can lead to increased volatility. Additionally, consider stocks or stock mutual funds that invest in different market caps (sizes) and have different investing styles, such as both value and growth investing.

On to fixed-income investments: Do your bond funds hold bonds of different maturities — short, medium and long-term — and types, such as government and corporate? Different types of bonds react in their own way to interest rate changes. Long-term bonds, for instance, are more sensitive to rate changes than short-term bonds.

Interest rates will always fluctuate in response to economic conditions. Rather than trying to guess the Federal Reserve’s next move, why not concentrate on creating a portfolio that will serve your needs well — no matter which way rates go?

If you would like to review your current investment portfolio or discuss any other financial planning matters, please don’t hesitate to contact us or visit our website at We are a fee-only fiduciary financial planning firm that always puts your interests first.  If you are not a client yet, an initial consultation is complimentary and there is never any pressure or hidden sales pitch.

What Is a Stretch IRA?

A stretch IRA is a traditional IRA that passes from the account owner to a younger beneficiary at the time of the account owner’s death. Since the younger beneficiary has a longer life expectancy than the original IRA owner, he or she will be able to “stretch” the life of the IRA by receiving smaller required minimum distributions (RMDs) each year over his or her life span. More money can then remain in the IRA with the potential for continued tax-deferred growth.

Creating a stretch IRA has no effect on the account owner’s RMD requirements, which continue to be based on his or her life expectancy. Once the account owner dies, however, beneficiaries begin taking RMDs based on their own life expectancies. Whereas the owner of a stretch IRA must begin receiving RMDs after reaching age 70 1/2, beneficiaries of a stretch IRA begin receiving RMDs after the account owner’s death. In either scenario, distributions are taxable to the payee at then-current income tax rates.

It’s worth noting that beneficiaries also have the right to receive the full value of their inherited IRA assets by the end of the fifth year following the year of the account owner’s death. However, by opting to take only the required minimum amount instead, a beneficiary can theoretically stretch the IRA and tax-deferred growth throughout his or her lifetime.

If you do not currently have any IRA beneficiaries, employing the stretch technique by naming a (human) beneficiary could provide significant long-term benefits. Special rules apply to naming a trust or estate as IRA beneficiaries, so it’s best to consult a tax or financial planner to discuss the consequences and pitfalls.

Added Perspectives

Your enhanced ability to stretch IRA assets is a direct result of an IRS decision to simplify the rules regarding RMDs from IRAs. The new rules allow beneficiaries to be named after the account owner’s RMDs have begun, and beneficiary designations can be changed after the account owner’s death (although no new beneficiaries can be named at that point). Also, the amount of a beneficiary’s RMD is based on his or her own life expectancy, even if the original account owner’s RMDs had already begun.

Note that the rules presented in this article apply to traditional IRAs bequeathed to a non-spousal beneficiary. Special rules apply to spousal beneficiaries.

So if you’re unlikely to deplete your IRA assets during your lifetime, consider creating a multi-generational stretch IRA. By doing so, you could build long-term financial security for a loved one while minimizing estate taxes.

If you would like to review your current beneficiary designations or discuss any other financial planning matters, please don’t hesitate to contact us or visit our website at We are a fee-only fiduciary financial planning firm that always puts your interests first.  If you are not a client yet, an initial consultation is complimentary and there is never any pressure or hidden sales pitch.

Tax Statistics: Where the money comes from

As the tax filing deadline approaches, Money Magazine has offered some interesting statistics on our annual ritual. In the early months, the IRS says that roughly 83% of all returns have resulted in refunds, with an average refund of $2,893 per return. In all, roughly eight out of ten filers qualify for a refund, and this year’s refund is in line with previous year averages.

Meanwhile, the IRS website notes that in the past few years, roughly 47% of Americans were below the threshold where they had to pay income taxes—which is where the famous “47 percenters” phrase came from in the Romney presidential campaign. However virtually all of those Americans paid FICA taxes. In all, 185.5 million income tax returns were filed last year, but only 34,000 estate tax returns and just 335,000 gift tax returns. The government collected $1.64 trillion in individual income taxes, compared with $353 billion in business income taxes. In aggregate, Californians paid the most taxes, at $369 billion, well ahead of Texas ($265 billion) and New York ($251 billion). At the other end of the spectrum, the citizens of Vermont paid $4.3 billion and people and companies living in Wyoming paid $4.9 billion,

Finally, there’s an interesting comparison. The King James Bible totals around 700,000 words, whereas the U.S. Federal Tax Code numbers 3.7 million words.

If you would like to review your current tax situation or discuss any other financial planning matters, please don’t hesitate to contact us or visit our website at We are a fee-only fiduciary financial planning firm that always puts your interests first.  If you are not a client yet, an initial consultation is complimentary and there is never any pressure or hidden sales pitch.


 TheMoneyGeek thanks guest writer Bob Veres for writing this post.

2015 First Quarter Report: Stop Awaiting the Fed

The first quarter of the new year has brought us small positive returns in many of the U.S. and global indices, and more than the usual amount of anxiety along with them.

The Wilshire 5000–the broadest measure of U.S. stocks and bonds—was up 1.61% for the first three months of 2015, which is remarkable considering that the index lost .75% on the last day of the quarter. The comparable Russell 3000 index has gained 1.80% so far this year.

The Wilshire U.S. Large Cap index gained 1.27% in the first three months of 2015. The Russell 1000 large-cap index was up 1.59%, while the widely-quoted S&P 500 index of large company stocks posted a gain of 0.44% in the first quarter of the year.

The Wilshire U.S. Mid-Cap index gained 5.77% for the quarter. The Russell Midcap Index was up 3.95%.

Small company stocks, as measured by the Wilshire U.S. Small-Cap index, gave investors a 4.51% return during three months of the year. The comparable Russell 2000 Small-Cap Index was up 4.32%, while the technology-heavy NASDAQ Composite Index gained 3.48% for the quarter.

Meanwhile, global markets are showing signs of life, which means returns comparable to the U.S. stock market. The broad-based EAFE index of companies in developed foreign economies gained 4.19% in dollar terms in the first quarter of the year, in part because Far Eastern stocks were up 8.27%. In aggregate, European stocks gained 5.15%, although they are still down more than 8% over the past 12 months. Emerging markets stocks of less developed countries, as represented by the EAFE EM index, fared less well, gaining 1.91% for the quarter. Many emerging markets are highly dependent on strong crude prices and stronger currencies, two factors working against them during this quarter.

Looking over the other investment categories, real estate investments, as measured by the Wilshire U.S. REIT index, was up 4.67% for the first quarter, despite falling 0.87% on the final day. Commodities, as measured by the S&P GSCI index, continued their losing ways, dropping 8.22% of their value in the first quarter, largely because of continuing drops in oil prices.

If you were watching the markets day-to-day, you experienced a mild roller coaster, what trading professionals refer to as a sideways market. One day it was up, the next down, each day (or week) seeming to erase the gains or losses of the previous ones. The best explanation for this phenomenon is that investors are still looking over their shoulders at interest rates, waiting for bond yields to jump higher, making bonds more competitive with stocks and triggering an outflow from the stock market that could (so the reasoning goes) cause a bear market in U.S. equities.

However, investors have been waiting for this shoe to drop for the better part of three years, and meanwhile, interest rates have drifted decidedly lower in the first quarter. The Bloomberg U.S. Corporate Bond Index now has an effective yield of 2.93%. 30-year Treasuries are yielding 2.48%, roughly 0.3% lower than in December, and 10-year Treasuries currently yield 1.87%, down from 2.17% at the beginning of the year. At the low end, you need a microscope to see the yield on 3-month T-bills, at 0.02%; 6-month bills are only slightly more generous, at 0.10%.

This interest rate watch has created a peculiar dynamic where up is down and down is up in terms of how traders and stock market gamblers look at the future. The generally positive economic news is greeted with dismay (The Fed will notice and start raising rates sooner rather than later! Boo!) and any bad news sends the stock market back up again into mild euphoria (The Fed might hold off another quarter! Yay!).

There are several obvious problems with this. First, probably least important, the Fed’s future actions are inscrutable. You will hear knowledgeable Fed-watchers say that the Fed will take action as early as June or as late as next year, and none of them really know.

Second, small incremental rises in interest rates are not closely associated with bear markets, as everybody seems to assume. Figure 1 may be a little hard to interpret, but each blue square shows the price/earnings ratio for the U.S. stock market as a whole after interest rates have risen to particular levels, almost all of them higher than today. What you see is that when rates have gone up in the past, the price people will pay for stocks has also gone up. Why? For exactly the reason you think: rising rates are a sign of a healthy economy, which is precisely why the Federal Reserve Board would decide that stimulus is no longer necessary. Companies—and their stocks—tend to thrive in healthy economies.

CA - 2015-4-1 - Figure 1

The chart also shows that rates can get too high for the health of stocks—the cutoff point seems to be up around 5.5% to 6%. But incremental quarter-point rises are not going to take the U.S. economy into that territory for a long time. History has shown that markets and interest rates can go up together for several quarters, after the market gets over the initial “shock” of the first interest rate hike. So far, the fed has given every indication that they will remain accommodative and patient.

Finally, we should all welcome the Fed pullback, not fear it. A lot of the uncertainty among traders and even long-term investors is coming from anxiety over how this experiment is going to end. The U.S. Central bank has directly intervened in the markets and in the economy, and is still doing so. When that ends, normal market forces will take over, and we’ll all have a better handle on what “normal” means in this economic era. Is there great demand for credit to fuel growth? What would rational investors pay for Treasury and corporate bonds if they weren’t bidding against an 800-pound gorilla? Would retirees prefer an absolutely certain 4.5% return on 30-year Treasury bonds or the less certain (but historically higher) returns they can get from the stock market? These are questions that all of us would like to know the answer to, and we won’t until all the quantitative easing and interventions have ended.

What DO we know? Figure 2 shows that the U.S. economy is less dependent on foreign oil than at any time since 1987, and the trend is moving toward complete independence. Oil—and energy generally—is cheaper now than it has been in several decades, which makes our lives, and the production of goods and services, less expensive.

CA - 2015-4-1 - Figure 2

Meanwhile, more Americans are working. Figure 3 shows that the U.S. unemployment rate—at 5.5%—is trending dramatically lower, and is now reaching levels that are actually below the long-term norms. Unemployment today is lower than the rate for much of the booming ‘90s, and is approaching the lows of the early 1970s.

CA - 2015-4-1 - Figure 3

And real GDP—the broadest measure of economic activity in the United States—increased 2.4% last year, after rising 2.2% the previous year.   America is growing. Not rapidly, but slow growth might not be so terrible. Rapid economic growth has, in the past, often preceded economic recessions, where excesses had to be corrected. Slow, steady growth may be boring, but it’s certainly not bad news for the economy or the markets. For fun, look at Figure 4, which shows, in a creative way, the size of the U.S. economy compared with the rest of the world. Each U.S. state is labeled with an entire country whose total economic output is roughly equal to that state’s. The point: the U.S. is still a colossus that stands across the global economy.

CA - 2015-4-1 - Figure 4

It has been said that people lose far more money in opportunity costs by trying to avoid future market downturns while the markets are still going up, than by holding their ground during actual downturns. And, in fact, in every case so far, the U.S. market has eventually made up the ground it lost in every bear market we’ve experienced.  The last trading day of the 1st quarter looked quite bearish, as have many other gloomy trading days during this seven-year bull market. It seems like every week, somebody else has predicted an imminent decline that has not happened. People who listened to the alarmists lost out on solid returns. You filter out the good news at your peril.

For our client portfolios we continue to take a somewhat defensive stance as this aging bull market carries on.  Despite softening economic data during the past few months, we see little evidence or warning signs of an impending recession or severe bear market over the next 6-9 months, although that could change anytime. Nonetheless, we await opportunities to re-deploy some cash, but the market has been recalcitrant to give much of a pullback from its recent highs.  Bull markets rarely die of old age; they often die of over-exuberance.  So far, we’re not seeing much of a rush to equities; rather, we see the market still climbing the proverbial wall of worry.

If you would like to review your current investment portfolio or discuss any other financial planning matters, please don’t hesitate to contact us or visit our website at We are a fee-only fiduciary financial planning firm that always puts your interests first.  If you are not a client yet, an initial consultation is complimentary and there is never any pressure or hidden sales pitch.

Happy Easter!


Wilshire index data:

Russell index data:

S&P index data:–p-us-l–

Nasdaq index data:

International indices:

Commodities index data:

Treasury market rates:

TheMoneyGeek thanks guest writer Bob Veres for co-writing this post.