How Understanding Interest Rates & Inflation Can Improve Your Investing

July 28, 2020

Estimated Reading Time: 6 minutes

How Understanding Interest Rates & Inflation Can Improve Your Investing

Interest rates are a driving force behind the revenue for institutional lenders and can be a painful financial expense for individuals. And while many financially savvy people stay on top of (or even take advantage of) the interest rates they have on their balance sheets, the reality is that navigating interest rates can be a valuable skill to have in the toolbox.

Add in the complexity of inflation and inflation rates, and the picture expands to become a multidimensional competition of small percentages that can have a significant impact on someone’s financials over time.

So what is an interest rate? What are inflation and the inflation rate? Are there any successful strategies for navigating one or both? In this article, we will take a high-level look at these questions and discuss some strategies for mitigating the damaging effects of both interest rates and inflation.

What is an Interest Rate?

An interest rate is the percentage of a loan that is charged to the person or institution borrowing the capital. On the other side, the interest rate is the premium the lender is charging to allow the borrower to use the borrowed capital.

An interest rate is generally noted as an APR, or annual percentage rate. Dividing the APR by 12 gives the monthly interest rate, which can be useful in determining how much of a payment is going towards paying down the principal and how much is used to cover the interest payment.

Higher interest rates are bad for the borrower, but good for the lender. The reverse is also true - relatively lower interest rates can be in the best interest of the borrower. When we work with clients, sometimes we find opportunities to secure lower interest rates, which increases the capital in clients’ accounts.

With higher interest rates, individuals and institutions are less inclined to borrow capital because the cost to borrow the capital is higher. Instead, they are more likely to save, because the interest rates they receive may lead to a higher rate of return.

Similarly, with lower interest rates, entities are more inclined to borrow, because the cost of borrowing is relatively lower and the benefits of saving are also lower. Typically, we see higher investments in the market, which offer a greater rate of return than low-interest-rate bonds. This partially explains why decreasing interest rates (like we saw in 2019) spurs market growth.

The Fed Funds Rate

So how much of the marshmallow do you have to put away every month? For example’s sake, let’s assume you’re trying to save $1MM retirement account by the age of 65. As you grow older, the contributions grow exponentially. The chart below assumes a growth rate of 7% in a tax-advantaged account:

What is Inflation?

Inflation is closely related to interest rates (as we’ve seen above). When there is a larger amount of money available, the value of the money can lessen. Inflation is an increase in prices, which leads to a fall in the value of a currency.

For individuals and institutions holding tangible assets, like materials or property, inflation may be a good actor when it raises the price of these assets. When it comes to cash, however, inflation is generally a bad thing, as it decreases the value of each dollar.

The Consumer Price Index (CPI) is the standard inflationary measure accounting for the increase of prices over time. For example, the price of a cup of coffee in 1970 was $0.25. Today, the same cup of coffee costs about $1.60. The U.S. Bureau of Labor Statistics has been reporting on inflation and the rate of inflation since 1913.

Protecting Against Inflation & The Real Interest Rate

While inflation is generally bad for cash-holders, leveraging interest rates to combat inflation can often be an effective strategy.

Sometimes we see clients who have a large cash position in their portfolio. Whether they are using the cash position as a hedge against risk or to protect their capital, the cash in their portfolio becomes a negatively-performing asset when accounting for inflation. This is why we recommend investing in lower-risk securities instead of holding a cash position.

However, even some lower-risk securities may not be a strong defense against inflation. Historically, treasury bonds have been a solid, low-risk defense against inflation. In today’s economic environment, though, they are no longer a viable option. We look to the real interest rate to see where we can use low-risk interest rate investments to counter inflation.

The real interest rate is calculated by subtracting the inflation rate from the interest rate. As of today (July 28, 2020), the 10-Year Real Interest Rate is -0.90% (10-Year Interest Rate of 0.60%; Inflation Rate of 1.60%)*, which is the lowest we have seen in over a decade. Continuing to invest in a security that has a lower interest rate or yield than the current inflation rate will lead to a perpetual decrease in the value of the investment. For investors, this means that they must take on a higher degree of risk to continue to outpace inflation.

What Can We Do Instead?

As long as the real interest rate remains negative, investors must turn to higher-yielding securities to generate a positive return that outpaces inflation. Examples would include corporate bonds or bond funds, which are relatively higher-risk than treasury bonds. We recommend various lower-risk fixed income funds to our clients that help them stay ahead of inflation (as part of their larger portfolio).

Until interest rates increase, there will be less opportunities for investors to choose lower-risk securities that can generate a net positive return for their capital. We can only hope that as the current COVID-19 pandemic blows over the option to invest in low-risk treasuries again becomes available to investors.

If you have any questions about your current financial strategy, or would like one of our advisors to review your current low-risk positions, we are happy to help.

 


*Forecasted inflation rate as of July 27, 2020

Important Disclosure Information

Past performance may not be indicative of future results. Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product (including the investments and/or investment strategies recommended or undertaken by Chicago Partners Investment Group LLC (“CP”), or any non-investment related content, made reference to directly or indirectly in this commentary will be profitable, equal any corresponding indicated historical performance level(s), be suitable for your portfolio or individual situation, or prove successful. Due to various factors, including changing market conditions and/or applicable laws, the content may no longer be reflective of current opinions or positions. Moreover, you should not assume that any discussion or information contained in this commentary serves as the receipt of, or as a substitute for, personalized investment advice from CP. Please remember to contact CP, in writing, if there are any changes in your personal/financial situation or investment objectives for the purpose of reviewing/evaluating/revising our previous recommendations and/or services, or if you would like to impose, add, or to modify any reasonable restrictions to our investment advisory services. CP is neither a law firm nor a certified public accounting firm and no portion of the commentary content should be construed as legal or accounting advice. A copy of the CP’s current written disclosure Brochure discussing our advisory services and fees continues to remain available upon request.

July 28, 2020

Estimated Reading Time: 6 minutes

How Understanding Interest Rates & Inflation Can Improve Your Investing

Interest rates are a driving force behind the revenue for institutional lenders and can be a painful financial expense for individuals. And while many financially savvy people stay on top of (or even take advantage of) the interest rates they have on their balance sheets, the reality is that navigating interest rates can be a valuable skill to have in the toolbox.

Add in the complexity of inflation and inflation rates, and the picture expands to become a multidimensional competition of small percentages that can have a significant impact on someone’s financials over time.

So what is an interest rate? What are inflation and the inflation rate? Are there any successful strategies for navigating one or both? In this article, we will take a high-level look at these questions and discuss some strategies for mitigating the damaging effects of both interest rates and inflation.

What is an Interest Rate?

An interest rate is the percentage of a loan that is charged to the person or institution borrowing the capital. On the other side, the interest rate is the premium the lender is charging to allow the borrower to use the borrowed capital.

An interest rate is generally noted as an APR, or annual percentage rate. Dividing the APR by 12 gives the monthly interest rate, which can be useful in determining how much of a payment is going towards paying down the principal and how much is used to cover the interest payment.

Higher interest rates are bad for the borrower, but good for the lender. The reverse is also true - relatively lower interest rates can be in the best interest of the borrower. When we work with clients, sometimes we find opportunities to secure lower interest rates, which increases the capital in clients’ accounts.

With higher interest rates, individuals and institutions are less inclined to borrow capital because the cost to borrow the capital is higher. Instead, they are more likely to save, because the interest rates they receive may lead to a higher rate of return.

Similarly, with lower interest rates, entities are more inclined to borrow, because the cost of borrowing is relatively lower and the benefits of saving are also lower. Typically, we see higher investments in the market, which offer a greater rate of return than low-interest-rate bonds. This partially explains why decreasing interest rates (like we saw in 2019) spurs market growth.

The Fed Funds Rate

So how much of the marshmallow do you have to put away every month? For example’s sake, let’s assume you’re trying to save $1MM retirement account by the age of 65. As you grow older, the contributions grow exponentially. The chart below assumes a growth rate of 7% in a tax-advantaged account:

What is Inflation?

Inflation is closely related to interest rates (as we’ve seen above). When there is a larger amount of money available, the value of the money can lessen. Inflation is an increase in prices, which leads to a fall in the value of a currency.

For individuals and institutions holding tangible assets, like materials or property, inflation may be a good actor when it raises the price of these assets. When it comes to cash, however, inflation is generally a bad thing, as it decreases the value of each dollar.

The Consumer Price Index (CPI) is the standard inflationary measure accounting for the increase of prices over time. For example, the price of a cup of coffee in 1970 was $0.25. Today, the same cup of coffee costs about $1.60. The U.S. Bureau of Labor Statistics has been reporting on inflation and the rate of inflation since 1913.

Protecting Against Inflation & The Real Interest Rate

While inflation is generally bad for cash-holders, leveraging interest rates to combat inflation can often be an effective strategy.

Sometimes we see clients who have a large cash position in their portfolio. Whether they are using the cash position as a hedge against risk or to protect their capital, the cash in their portfolio becomes a negatively-performing asset when accounting for inflation. This is why we recommend investing in lower-risk securities instead of holding a cash position.

However, even some lower-risk securities may not be a strong defense against inflation. Historically, treasury bonds have been a solid, low-risk defense against inflation. In today’s economic environment, though, they are no longer a viable option. We look to the real interest rate to see where we can use low-risk interest rate investments to counter inflation.

The real interest rate is calculated by subtracting the inflation rate from the interest rate. As of today (July 28, 2020), the 10-Year Real Interest Rate is -0.90% (10-Year Interest Rate of 0.60%; Inflation Rate of 1.60%)*, which is the lowest we have seen in over a decade. Continuing to invest in a security that has a lower interest rate or yield than the current inflation rate will lead to a perpetual decrease in the value of the investment. For investors, this means that they must take on a higher degree of risk to continue to outpace inflation.

What Can We Do Instead?

As long as the real interest rate remains negative, investors must turn to higher-yielding securities to generate a positive return that outpaces inflation. Examples would include corporate bonds or bond funds, which are relatively higher-risk than treasury bonds. We recommend various lower-risk fixed income funds to our clients that help them stay ahead of inflation (as part of their larger portfolio).

Until interest rates increase, there will be less opportunities for investors to choose lower-risk securities that can generate a net positive return for their capital. We can only hope that as the current COVID-19 pandemic blows over the option to invest in low-risk treasuries again becomes available to investors.

If you have any questions about your current financial strategy, or would like one of our advisors to review your current low-risk positions, we are happy to help.

 


*Forecasted inflation rate as of July 27, 2020

Important Disclosure Information

Past performance may not be indicative of future results. Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product (including the investments and/or investment strategies recommended or undertaken by Chicago Partners Investment Group LLC (“CP”), or any non-investment related content, made reference to directly or indirectly in this commentary will be profitable, equal any corresponding indicated historical performance level(s), be suitable for your portfolio or individual situation, or prove successful. Due to various factors, including changing market conditions and/or applicable laws, the content may no longer be reflective of current opinions or positions. Moreover, you should not assume that any discussion or information contained in this commentary serves as the receipt of, or as a substitute for, personalized investment advice from CP. Please remember to contact CP, in writing, if there are any changes in your personal/financial situation or investment objectives for the purpose of reviewing/evaluating/revising our previous recommendations and/or services, or if you would like to impose, add, or to modify any reasonable restrictions to our investment advisory services. CP is neither a law firm nor a certified public accounting firm and no portion of the commentary content should be construed as legal or accounting advice. A copy of the CP’s current written disclosure Brochure discussing our advisory services and fees continues to remain available upon request.

How Understanding Interest Rates & Inflation Can Improve Your Investing

July 28, 2020

Estimated Reading Time: 6 minutes

How Understanding Interest Rates & Inflation Can Improve Your Investing

Interest rates are a driving force behind the revenue for institutional lenders and can be a painful financial expense for individuals. And while many financially savvy people stay on top of (or even take advantage of) the interest rates they have on their balance sheets, the reality is that navigating interest rates can be a valuable skill to have in the toolbox.
Add in the complexity of inflation and inflation rates, and the picture expands to become a multidimensional competition of small percentages that can have a significant impact on someone’s financials over time.
So what is an interest rate? What are inflation and the inflation rate? Are there any successful strategies for navigating one or both? In this article, we will take a high-level look at these questions and discuss some strategies for mitigating the damaging effects of both interest rates and inflation.

What is an Interest Rate?

An interest rate is the percentage of a loan that is charged to the person or institution borrowing the capital. On the other side, the interest rate is the premium the lender is charging to allow the borrower to use the borrowed capital.
An interest rate is generally noted as an APR, or annual percentage rate. Dividing the APR by 12 gives the monthly interest rate, which can be useful in determining how much of a payment is going towards paying down the principal and how much is used to cover the interest payment.
Higher interest rates are bad for the borrower, but good for the lender. The reverse is also true – relatively lower interest rates can be in the best interest of the borrower. When we work with clients, sometimes we find opportunities to secure lower interest rates, which increases the capital in clients’ accounts.
With higher interest rates, individuals and institutions are less inclined to borrow capital because the cost to borrow the capital is higher. Instead, they are more likely to save, because the interest rates they receive may lead to a higher rate of return.
Similarly, with lower interest rates, entities are more inclined to borrow, because the cost of borrowing is relatively lower and the benefits of saving are also lower. Typically, we see higher investments in the market, which offer a greater rate of return than low-interest-rate bonds. This partially explains why decreasing interest rates (like we saw in 2019) spurs market growth.

The Fed Funds Rate

So how much of the marshmallow do you have to put away every month? For example’s sake, let’s assume you’re trying to save $1MM retirement account by the age of 65. As you grow older, the contributions grow exponentially. The chart below assumes a growth rate of 7% in a tax-advantaged account:

What is Inflation?

Inflation is closely related to interest rates (as we’ve seen above). When there is a larger amount of money available, the value of the money can lessen. Inflation is an increase in prices, which leads to a fall in the value of a currency.
For individuals and institutions holding tangible assets, like materials or property, inflation may be a good actor when it raises the price of these assets. When it comes to cash, however, inflation is generally a bad thing, as it decreases the value of each dollar.
The Consumer Price Index (CPI) is the standard inflationary measure accounting for the increase of prices over time. For example, the price of a cup of coffee in 1970 was $0.25. Today, the same cup of coffee costs about $1.60. The U.S. Bureau of Labor Statistics has been reporting on inflation and the rate of inflation since 1913.

Protecting Against Inflation & The Real Interest Rate

While inflation is generally bad for cash-holders, leveraging interest rates to combat inflation can often be an effective strategy.
Sometimes we see clients who have a large cash position in their portfolio. Whether they are using the cash position as a hedge against risk or to protect their capital, the cash in their portfolio becomes a negatively-performing asset when accounting for inflation. This is why we recommend investing in lower-risk securities instead of holding a cash position.
However, even some lower-risk securities may not be a strong defense against inflation. Historically, treasury bonds have been a solid, low-risk defense against inflation. In today’s economic environment, though, they are no longer a viable option. We look to the real interest rate to see where we can use low-risk interest rate investments to counter inflation.
The real interest rate is calculated by subtracting the inflation rate from the interest rate. As of today (July 28, 2020), the 10-Year Real Interest Rate is -0.90% (10-Year Interest Rate of 0.60%; Inflation Rate of 1.60%)*, which is the lowest we have seen in over a decade. Continuing to invest in a security that has a lower interest rate or yield than the current inflation rate will lead to a perpetual decrease in the value of the investment. For investors, this means that they must take on a higher degree of risk to continue to outpace inflation.

What Can We Do Instead?

As long as the real interest rate remains negative, investors must turn to higher-yielding securities to generate a positive return that outpaces inflation. Examples would include corporate bonds or bond funds, which are relatively higher-risk than treasury bonds. We recommend various lower-risk fixed income funds to our clients that help them stay ahead of inflation (as part of their larger portfolio).
Until interest rates increase, there will be less opportunities for investors to choose lower-risk securities that can generate a net positive return for their capital. We can only hope that as the current COVID-19 pandemic blows over the option to invest in low-risk treasuries again becomes available to investors.
If you have any questions about your current financial strategy, or would like one of our advisors to review your current low-risk positions, we are happy to help.
 

*Forecasted inflation rate as of July 27, 2020
Important Disclosure Information
Past performance may not be indicative of future results. Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product (including the investments and/or investment strategies recommended or undertaken by Chicago Partners Investment Group LLC (“CP”), or any non-investment related content, made reference to directly or indirectly in this commentary will be profitable, equal any corresponding indicated historical performance level(s), be suitable for your portfolio or individual situation, or prove successful. Due to various factors, including changing market conditions and/or applicable laws, the content may no longer be reflective of current opinions or positions. Moreover, you should not assume that any discussion or information contained in this commentary serves as the receipt of, or as a substitute for, personalized investment advice from CP. Please remember to contact CP, in writing, if there are any changes in your personal/financial situation or investment objectives for the purpose of reviewing/evaluating/revising our previous recommendations and/or services, or if you would like to impose, add, or to modify any reasonable restrictions to our investment advisory services. CP is neither a law firm nor a certified public accounting firm and no portion of the commentary content should be construed as legal or accounting advice. A copy of the CP’s current written disclosure Brochure discussing our advisory services and fees continues to remain available upon request.

July 28, 2020

Estimated Reading Time: 6 minutes

How Understanding Interest Rates & Inflation Can Improve Your Investing

Interest rates are a driving force behind the revenue for institutional lenders and can be a painful financial expense for individuals. And while many financially savvy people stay on top of (or even take advantage of) the interest rates they have on their balance sheets, the reality is that navigating interest rates can be a valuable skill to have in the toolbox.
Add in the complexity of inflation and inflation rates, and the picture expands to become a multidimensional competition of small percentages that can have a significant impact on someone’s financials over time.
So what is an interest rate? What are inflation and the inflation rate? Are there any successful strategies for navigating one or both? In this article, we will take a high-level look at these questions and discuss some strategies for mitigating the damaging effects of both interest rates and inflation.

What is an Interest Rate?

An interest rate is the percentage of a loan that is charged to the person or institution borrowing the capital. On the other side, the interest rate is the premium the lender is charging to allow the borrower to use the borrowed capital.
An interest rate is generally noted as an APR, or annual percentage rate. Dividing the APR by 12 gives the monthly interest rate, which can be useful in determining how much of a payment is going towards paying down the principal and how much is used to cover the interest payment.
Higher interest rates are bad for the borrower, but good for the lender. The reverse is also true – relatively lower interest rates can be in the best interest of the borrower. When we work with clients, sometimes we find opportunities to secure lower interest rates, which increases the capital in clients’ accounts.
With higher interest rates, individuals and institutions are less inclined to borrow capital because the cost to borrow the capital is higher. Instead, they are more likely to save, because the interest rates they receive may lead to a higher rate of return.
Similarly, with lower interest rates, entities are more inclined to borrow, because the cost of borrowing is relatively lower and the benefits of saving are also lower. Typically, we see higher investments in the market, which offer a greater rate of return than low-interest-rate bonds. This partially explains why decreasing interest rates (like we saw in 2019) spurs market growth.

The Fed Funds Rate

So how much of the marshmallow do you have to put away every month? For example’s sake, let’s assume you’re trying to save $1MM retirement account by the age of 65. As you grow older, the contributions grow exponentially. The chart below assumes a growth rate of 7% in a tax-advantaged account:

What is Inflation?

Inflation is closely related to interest rates (as we’ve seen above). When there is a larger amount of money available, the value of the money can lessen. Inflation is an increase in prices, which leads to a fall in the value of a currency.
For individuals and institutions holding tangible assets, like materials or property, inflation may be a good actor when it raises the price of these assets. When it comes to cash, however, inflation is generally a bad thing, as it decreases the value of each dollar.
The Consumer Price Index (CPI) is the standard inflationary measure accounting for the increase of prices over time. For example, the price of a cup of coffee in 1970 was $0.25. Today, the same cup of coffee costs about $1.60. The U.S. Bureau of Labor Statistics has been reporting on inflation and the rate of inflation since 1913.

Protecting Against Inflation & The Real Interest Rate

While inflation is generally bad for cash-holders, leveraging interest rates to combat inflation can often be an effective strategy.
Sometimes we see clients who have a large cash position in their portfolio. Whether they are using the cash position as a hedge against risk or to protect their capital, the cash in their portfolio becomes a negatively-performing asset when accounting for inflation. This is why we recommend investing in lower-risk securities instead of holding a cash position.
However, even some lower-risk securities may not be a strong defense against inflation. Historically, treasury bonds have been a solid, low-risk defense against inflation. In today’s economic environment, though, they are no longer a viable option. We look to the real interest rate to see where we can use low-risk interest rate investments to counter inflation.
The real interest rate is calculated by subtracting the inflation rate from the interest rate. As of today (July 28, 2020), the 10-Year Real Interest Rate is -0.90% (10-Year Interest Rate of 0.60%; Inflation Rate of 1.60%)*, which is the lowest we have seen in over a decade. Continuing to invest in a security that has a lower interest rate or yield than the current inflation rate will lead to a perpetual decrease in the value of the investment. For investors, this means that they must take on a higher degree of risk to continue to outpace inflation.

What Can We Do Instead?

As long as the real interest rate remains negative, investors must turn to higher-yielding securities to generate a positive return that outpaces inflation. Examples would include corporate bonds or bond funds, which are relatively higher-risk than treasury bonds. We recommend various lower-risk fixed income funds to our clients that help them stay ahead of inflation (as part of their larger portfolio).
Until interest rates increase, there will be less opportunities for investors to choose lower-risk securities that can generate a net positive return for their capital. We can only hope that as the current COVID-19 pandemic blows over the option to invest in low-risk treasuries again becomes available to investors.
If you have any questions about your current financial strategy, or would like one of our advisors to review your current low-risk positions, we are happy to help.
 

*Forecasted inflation rate as of July 27, 2020
Important Disclosure Information
Past performance may not be indicative of future results. Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product (including the investments and/or investment strategies recommended or undertaken by Chicago Partners Investment Group LLC (“CP”), or any non-investment related content, made reference to directly or indirectly in this commentary will be profitable, equal any corresponding indicated historical performance level(s), be suitable for your portfolio or individual situation, or prove successful. Due to various factors, including changing market conditions and/or applicable laws, the content may no longer be reflective of current opinions or positions. Moreover, you should not assume that any discussion or information contained in this commentary serves as the receipt of, or as a substitute for, personalized investment advice from CP. Please remember to contact CP, in writing, if there are any changes in your personal/financial situation or investment objectives for the purpose of reviewing/evaluating/revising our previous recommendations and/or services, or if you would like to impose, add, or to modify any reasonable restrictions to our investment advisory services. CP is neither a law firm nor a certified public accounting firm and no portion of the commentary content should be construed as legal or accounting advice. A copy of the CP’s current written disclosure Brochure discussing our advisory services and fees continues to remain available upon request.