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The following post comes from Gary Foreman at partner site The Dollar Stretcher.
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 percent. We also saw mortgages in the 12-plus percent range during the late ’70s and early ’80s. Now we’re seeing CD rates of 1 and 2 percent.
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 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 they’re borrowing and their newly lowered credit ratings, cost to borrow will increase nearly 40 percent (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 percent growth in the economy in 2012. Most of that growth will come from consumers. Since the average consumer isn’t getting raises in this economy, the only way they can spend more is to borrow more.
Combined, that means there will be a greater demand for borrowed money in 2012. 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 boomers remember the ’70s 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 ’80s. 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, often a decade or more in the future.
What happened? They committed to loaning money at 5 or 6 percent 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 percentage point on a three-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 also 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.
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