6 Financial Planning Considerations In A High Rate Environment

Investors are waiting with bated breath for the Federal Reserve to lower interest rates in 2024. The Fed signaled a probability of lowering rates this year, which historically has benefited the stock market. However, at this point, rates are still high and may not be lowered for many months.

While this reality may be frustrating, there are still a variety of available planning opportunities that may help many families, especially those approaching retirement. Here are some points to consider in this high-rate environment.

1. Beware of the risks of using money market funds: Money market funds are offering historically attractive yields of approximately 5%, as of this writing. That yield almost risk free makes them seem like a no-brainer. However, it’s also worth noting that yields on money markets will not outpace inflation over the long-term. Therefore, investors should be careful about allocating too much of their portfolio to these funds.

For folks with longer-term goals that want to outpace inflation, the stock market is a more prudent solution. While there is volatility over the short-term, over time stocks have historically outpaced inflation. Sadly, some investors may feel the illusion of “safety” and keep too much money in cash or cash equivalents. This decision can be financially devastating to building your nest egg.

2. Ladder CDs/Treasuries: In the theme of conservative places to park cash for short-term goals, both CDs and short-term treasuries look appealing. Yields on these securities are historically high, making them a wonderful place to earn return on your cash. It’s worth keeping an eye on the yield curve to selectively pick fixed income products that offer an attractive yield over your investment time horizon.

3. Move up in credit quality: Risk and return are inextricably linked. If you want higher returns, it necessitates taking a higher level of risk. For years, investors were compelled to “stretch” for yield to meet their goals by purchasing riskier securities. Fortunately, investment grade bonds look more appealing today than they have in over a decade.

Investors can now receive competitive returns on high quality bonds without taking the same level of risk as in years past. Sure, securities like junk bonds and private credit may offer higher return potential. However, taking that extra level of risk may no longer be necessary for most investors to meet their goals.

4. Consider paying down your bad debt: The most important factor in determining how to approach one’s debt in this high interest rate environment is to first classify the type of debt with which you are burdened. Afterall, not all debt is created equal.

For example, credit card debt is the cancer of personal finance. The average credit card interest rate is nearly 23%. That can make even a small balance very quickly grow out of control and become insurmountable, especially in this high interest rate environment. In such a situation, investors may want to consider selling their investments, even at a loss, in order to pay down their credit card debt in full.

There is also so-called “good debt,” that may temporarily feel like a burden. For example, a homeowner who refinanced their mortgage in 2021 to a 15-year loan at a sub-3% interest rate should continue to maintain their loan at that historically low interest rate.

Finally, there are other types of debt that, while still not great, are less bad. One example is a variable-rate loan. The solution in such a situation depends on many factors, including when the rate is scheduled to rise, the purpose of the loan, and the client’s projected cash flow to pay down this debt. For a borrower with an investment property whose mortgage is set to climb higher, I would recommend evaluating the property’s monthly cash flows to determine if it is possible to keep the investment profitable for a few years until the market dynamics change or the investment goes up in value. Running to offload an investment just to wipe out debt may or may not be optimal depending on the situation.

5. Explore using a Charitable Remainder Trust (CRT): A CRT combines both philanthropy with tax planning. It is an irrevocable trust that pays an annual payment to an individual during the term of the trust, with the remainder passing to one or more named charities.

A CRT may be more appealing in a high interest rate environment given its reliance on the Section 7520 Rate. The 7520 Rate is set by the IRS and is a factor in various calculations such as remainder interests, charitable deductions, and minimum thresholds for sophisticated estate planning strategies. Since the value of the grantor’s retained interest in a CRT is lower when the Section 7520 rate is higher, the value of the interest passing to charity and, therefore, the grantor’s income tax deduction is higher. Furthermore, the grantor’s taxable estate is reduced by the assets gifted to the CRT, as well as all future appreciation on such assets.

6. Be mindful of estate planning strategies with less appeal: There are other strategies that are also linked to AFRs, or “Applicable Federal Rates” set by the Treasury, that may be less appealing in times of rising interest rates. Specific examples include a grantor retained annuity trust (GRAT), an intentionally defective grantor trust, and intra-family loans.

The GRAT assets and the value of the assets sold to an intentionally defective grantor trust must grow at a greater pace than the prevailing applicable federal rate to avoid gift or estate tax. Additionally, intra-family loans need to charge a higher interest rate than the AFR to avoid being treated as gift loans. In a high interest rate environment these conditions may become more difficult to satisfy.

It’s worth noting that these strategies with less appeal may still serve your planning goals. However, it’s important to pay close attention and evaluate their performance in the current interest rate environment.

Persistently high interest rates provide both challenges and opportunities. Folks who take the time to evaluate the market dynamics may find strategies to help them achieve their goals. Approaching investing with a discerning eye and positive attitude can help investors find opportunities in every market environment.

Securities offered through Kestra Investment Services, LLC (Kestra IS), member FINRA/SIPC. Investment Advisory Services offered through Kestra Advisory Services, LLC (Kestra AS), an affiliate of Kestra IS. ParkBridge Wealth Management is not affiliated with Kestra IS or Kestra AS. Investor Disclosures:

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