What Rising Rates Mean For You | AWM Insights #129
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Episode Summary
Rising interest rates have dominated headlines for the last few months, but which rate is the most important to you? Should you be concerned?
The rate you’ve likely heard the most about is the Fed Funds rate. In short, this is the interest rate that banks charge each other if they need to borrow or lend in excess of their reserves. This rate is set by the Federal Reserve and is the main policy tool used to influence other short-term rates in an effort to cool inflation.
Contrary to what you might hear, rising rates does not always mean the stock market will crash or even go down. Past evidence has shown no strong correlation and trying to time the market using this data would be a fool’s errand. Staying the course with your long-term strategy and trusting in your established protective reserve should give you confidence during these times.
In this episode of AWM Insights, Brandon and Justin discuss these rising rates, their potential impact on you, and how to navigate market downturns.
Have questions for an upcoming episode? Want to get free resources, book giveaways, and AWM gear? Want to hear about when we release new episodes? Text “insights” or the lightbulb emoji (💡) to Brandon at (602) 704-5574 to join our new AWM Insights Network. On an iPhone? Click HERE to join.
Episode Highlights
(0:27) There is no greater impact than working on your family and helping them become the center of that impact. Not just for today but into the future.
(1:38) Why doesn’t wealth transfer? How you can have more impact on future generations?
(1:44) Family wealth includes more than just dollars and cents. It includes values, history, and the stories that create family legacy.
(2:05) Intentionality is difficult. The numbers are unfortunate. It’s estimated that 70% of wealth is lost by the 2nd generation and 90% by the third generation.
(2:30) The “shirtsleeves to shirtsleeves” epidemic has been around for centuries.
(3:02) To break this trend, you have to begin the process. Doing nothing or passing it off to someone else isn’t the best solution.
(3:30) You shouldn’t be afraid of your kids inheriting large sums of money. You should feel confident they are prepared and educated on how to handle it when that times comes.
(3:50) Passing off the wealth to someone else probably won’t result in the greatest impact for your family. Training your own family and heirs to steward the wealth well is an incredible opportunity that you have a lot of control over.
(4:32) The data shows that 60% of the reason wealth doesn’t transfer is communication, and 25% is due to heirs being inadequately prepared. Technical knowledge only makes up a small amount of the problem.
(5:45) Lack of skillsets. Not knowing how to talk to your kids and failing to prepare them can be addressed. Setting the intent and fostering strong communication over decades provides the foundation for them to be successful.
(6:20) Not talking about money is common in our society. Communication should be encouraged and framed in the right way.
(7:00) Talking about the work, study, and effort that went into earning that wealth is a great opportunity to frame wealth the right way.
(7:56) Stewarding the wealth generation after generation becomes the mindset rather than just focusing on what you can do with it only in your lifetime.
(8:34) Wealth can be financial capital, human capital, social capital, and charitable intent. Each of these types of wealth deserve their own conversation.
(9:11) Generational wealth is more than just a portfolio and how big it is.
(9:23) The families that successfully transfer wealth are ones that take a step back and establish intentionality and a big picture vision.
(9:55) If you’re a business owner, you have utilized your intellectual capital and intelligence to create a new opportunity. Teaching financial capital is important but arguably more important is social capital. Relationships and the people you are around is an incredible opportunity to model for your children.
(11:02) Put your kids in a lunch with you and someone important and teach them the importance of relationships to begin building their social capital.
(11:45) The technical side or financial science is just one part of the equation.
(12:29) Building the foundation for a flourishing family that will make an impact for generations is a fulfilling endeavor.
(12:46) It’s never too early to start. The younger years are actually the most influential when it comes to money. It’s also never too late. The worst strategy is to not communicate and leave it to chance.
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+ Read the Transcript
Brandon Averill (00:04): Well, Justin, we're back for another episode here. And hopefully for those of you that don't know, we do record these via video. They're on YouTube. So I caught my son watching us the other day. And Luke was just laughing his, I won't say it, butt off but so for those of you that don't know tune into YouTube. You can actually see us as well as hear us, but let's jump into today's topic.
(00:26): In the news right now, a lot of talk about interest rates. We quote, unquote know what's going to happen, and let's be honest. The Fed is telegraphing stuff pretty well right now, but it looks like we're going to have a rise in interest rates on the Fed side. But we want to dig in today a little bit and talk about that and talk about how much can we actually tell about what's going to happen in portfolios, how we're preparing, what do you do when you see interest rate rises coming? Why are they happening? Just kind of dig into the topic overall. So let's start there, Justin. I think I'd love to know when somebody says to you, Hey, the Fed's raising rates or even more plain vanilla, rates are going up. How do we start to coach our clients to think about that?
Justin Dyer (01:13): Yeah, it is a common question. You're seeing all over the place right now, whether it's client conversations or in the financial media. The first rebuttal or response I would have is, well, what interest rates are you talking about? So usually what you're hearing about when you talk about the Fed raising interest rates is a specific interest rate, which is called the Fed funds rate. We're not going to go into great detail here, but that is a single interest rate in the market. It is one of the more important ones. So I'm not trying to diminish that whatsoever, but then there are actual interest rates that the government pays on their debt, on treasury bonds to label them simply. And then there are various maturities within that. There's a one year, there's a three month, there's a five year, 10 year, 30 year, et cetera. And each one of those points or maturities over this interest rate, what's called a yield curve, has its own distinct interest rate.
(02:15): And when the Fed goes to increase their interest rate, which they actually don't control directly, that's a whole nother topic. However, when they do that, when they say they're going to increase the Fed funds rate, that is most directly impacting the shorter end of that yield curve. So think about debt, or bonds, or fixed income that is maturing in a relatively short period of time. It can impact longer parts of the yield curve. It actually doesn't traditionally do that, or it impacts it in a inverse relationship. Meaning when the Fed increases interest rates, longer term interest rates decline on average. So it really starts with, Hey, what interest rate are you talking about? Right now we are talking a lot about the Fed funds rate specifically. That is what's in the news. That's what's been increased over the last year to date really let's call it broadly speaking. And it's looking like they're going to have another big increase coming up here in the short term.
Brandon Averill (03:19): And I think that's an interesting thing. When I talk to clients or when just talk to people in general, you start to think about interest rates. We typically think about interest rates, I think our brain jumps to the mortgage, right, a 30 year mortgage or something like that. So like you're saying the Fed maybe increasing the short term rates don't necessarily impact the mortgage rates directly. Now there may be a cause and effect there certainly, but there are a lot of other factors. How is the economy going, how is the housing market operating, there's all kinds of information that goes into that. And what we find, I've found this fascinating like you said, on average long term rates actually decline, but 40 to 50% of the time when the Fed raises rates long term rates come down, so even kind of more evidence beyond the average.
(04:10): So when we think about the impact of these short term rate changes, it's going to impact things like credit card debt for instance, those are going to adjust right away. But aside from that, I mean a lot of people and probably most people listening to this podcast don't really have a whole lot of, yeah I guess, impact from short term rate changes, unless we turn to what I think the news and everybody else's kind of throwing out there right now is what's the effect on equity. So what's the effect on stock market returns with some of these interest rate changes? And I'll let you dig into that. But spoiler alert, there's not a lot of correlation or a lot of predictability about, Hey, rates are going up. Does that mean it's bad for stocks? Does it mean it's good for stocks? I think it just, again, depends.
Justin Dyer (04:57): Yeah. And to unpack that a little bit, you can look, plot basically the return of just let's say the S&P 500 against increases in the Fed funds rate. That's what Brandon's alluding to. And if they were directly correlated or related to one another, when you compare those two variables with each other, you'd see an upward sloping line. If you actually look at the relationship over the history of when that has happened, when the Fed has increased rates and what's happened subsequently to the S&P 500 equity markets broadly speaking, there's no discernible relationship. Sometimes they go up. Sometimes they go down. Sometimes they go sideways. It really, the plot of that is it looks like a scatter plot, looks like a kid just took a pen and went nuts. Well, what's happened right now is it has been a headwind or it's been a drag or draw down on US equity markets.
(05:56): The logical explanation to that is if you think about it from a cost of capital. And what I mean by that, that is a kind of academic finance term, is if I'm a company and I want to go borrow money in the marketplace, go issue debt. If interest rates overall, all things being equal are higher, I'm going to have to pay more money for that debt. Now, if my finances are totally the same, guess what? My cost just went up and that potentially has a material impact on my bottom line, the profitability of my business, and therefore the market is re-pricing. That's one input in which the market is now re-pricing stocks and could be a driver of declines that we are experiencing. These markets are so incredibly complex. I'm using these words could be, maybe very selectively because there is no perfect crystal ball or perfect model that explains all this.
(06:56): And I'll go back to explaining the correlation between rates and equities. They are all over the place. There is no discernible relationship that ties those two things together, because there are so many different variables that could impact it in a given cycle. This time is really no different. Right now rates are the big headline, and inflation's the big headline. That's arguably driving market performance, but it's driving market performance until it doesn't really. And at that point in time, and you don't know when that point in time will come, you don't want to be playing this game of using rates or Fed funds rates to challenge or dictate where you are invested currently at the present moment.
(07:40): So again, we take a step back and we talk about this a lot. Having a plan in place ahead of time, being a long-term investor, et cetera, et cetera, which I'm not going to get into that a ton right now, but that's the message here. We know, actually. I mean, there's a very, very high likelihood that rates are going up more today when we're recording this, equity markets are actually up, even though we know in a couple days, rates are likely to go up. So that's a perfect little microcosm of why this is kind of such a fools errand, to an extent to try and use these things to time the market.
Brandon Averill (08:12): Yeah, I think it's kind of fascinating. I was reading a little bit preparing for this and we were talking about this. Even if you have that crystal ball, right, if you have the crystal ball on interest rates and what changes are going to happen, you still wouldn't be very successful in trying to forecast how to implement that. So there's a disconnect there. Right. Like you said it's highly likely rates are going up. It's highly likely it's going to be three quarters of a point and Fed rates. But even knowing that it's impossible because you can't look back on historical evidence and say, well, this means that equity markets are going up or they're going to go down. And if we knew that, right, then yeah, you would play that. And everybody would make a lot of money, but that in itself tells you, right, that if it was that predictive, if it was that sure of a thing, then all of it would be squashed out at the end of the day.
(09:05): So I think having that crystal ball. What we're not saying here is not to be concerned that increasing rates could impact your situation. They very well could. They're combating inflation. Right. That's another factor at play here. Inflation's potentially eating away at your future earnings or affecting your consumption. All of those things should be concerns. What we're saying is that the way to solve them is not to try to predict the future. What we're trying to say is the key takeaways here are tune out that noise, tune out the noise of, Hey, rates are going up. This is going to probably happen, or we're going to guess this is going to happen. Because at the end of the day, these people aren't forecasting anything. They're guessing. It's wishes of what's actually going to happen.
(09:54): So are you going to put your hands in people making wishes and predictions on TV, et cetera, or are you going to go back and devise, build a nice, solid financial structure that is going to give you a good experience over time? And that's really the key, right? It's not stick your head in the sand and act like nothing bad is happening. Something bad could be happening. The economy could go down, et cetera. But if you have a strong financial structure in place, then you're hedging the impact on your personal situation through that period.
Justin Dyer (10:29): Yeah, exactly. It's acknowledging that there's downside risk. And even in good times, you need to have that mindset. That is not something you can ever stick your head in the sand and just completely ignore. It's hard. It's actually a good time. I was going to say it's hard to kind of imagine that, but it's a good time to make this statement. We've had a tough year. Markets overall are off double digits let's say 15 to 20%, depending on when you're listening to this. And that's a bear market territory. The two, three years, or even the decade prior have been phenomenally good for equity markets. And in those periods of time, we often forget that risk and return are related. It's actually good to have a year like we are having right now. It sucks to actually be in it because you're seeing the actual dollars in portfolios and markets decline, but it gives us renewed confidence in a way that markets work, that markets take information, reprice that information a very efficient way.
(11:38): We've talked about the efficient markets and markets are largely efficient. It's not 100% efficient. Can they be wrong sometimes? Yes. Are they right all the time? No, but it's the best explainer of how markets work, taken information, reprice information. Then that's somewhat what you're seeing right now with interest rates and the overall macroeconomic environment. Markets this year are repricing that information. That's good. That's a healthy functioning market and gives us a higher expected return in equities and stocks looking forward long term. 10 plus years, you are expected, we expect to actually be rewarded for that quote, unquote risk you are taken on the equity side of things. So that's one comment on the equity side. And then with respect to inflation, what's going on now, it's having the protective reserve, having that piece of your portfolio constructed in a way that doesn't put your priorities and goals, your short term priorities and goals at risk to give you that staying power, to acknowledge that there's uncertainty about the future and to make sure that there's staying power again in your portfolio to deal with times of adversity.
Brandon Averill (12:49): And I think that's huge. And as we wrap up here, I think again, I just want to hit on the key takeaways that we want you to take away from this and that's control what you can control. Right. Build the financial structure, have a real good understanding of what your priorities are, what your resources are, marry those together. So that way you know, Hey, I'm going to weather storms. I'm going to get through periods of difficulty like we're going through currently. And quite frankly, be comforted in knowing that, Hey, I get to weather this storm. And it just means that markets are working effectively. It means that I'm going to get rewarded for taking this risk over the long periods of time. So control what you can control. Tune out that noise. There are a lot of messages being thrown at you nowadays more than ever social media, et cetera. If people are trying to predict and tell you that they know what's going to happen, I understand how that feels good to hear that and try to find some certainty, but the reality is they don't.
(13:52): And so what we're looking for is things get a lot more certain over longer periods of time. Short term, I mean, nobody knows what's going to happen in the next 30, 60, 90, even really a year from now, right? So focus on building that financial structure, tuning out the noise and just don't let it drive the decision making on the short term. So we hope you enjoyed this. Hopefully it was a little bit helpful on what's going on right now in the markets and what might be going on the rest of the week, depending on when you're listening to this. Before we close out, as you know, you can text us, text me directly. It's 602-704-5574. We'd love to hear from you. We'd love to hear the questions. If there are anything burning after rates probably go up, we can jump back on and talk about that as well. But until next time own your wealth, make an impact and always be a pro.