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Guarding Your Wealth for Senior Citizens
Think of Your Investment Portfolio as a Living,
Breathing Entity
Knowing how interest rates affect the business cycle,
helps you structure your portfolio
By Jeffrey D. Voudrie, CFP
 Dec. 26, 2007 - The effect interest rates have on
the performance of our economy cannot be overstated. Understanding how
interest rates affect the business cycle will help you know how to
structure your portfolio to achieve growth while minimizing risk. Read
on to learn more.
Would you wear a winter parka on a Florida beach in
the middle of summer? Of course not. I doubt any of us would wear a
bikini to go ice fishing in the middle of a Minnesota winter - I know I
wouldn’t!
Clothes are a tool that is used to help regulate
our body temperature. They protect us from the cold or keep us from
over-heating. Their proper use determines our comfort from one season to
the next. We don’t want our body temperature to wildly fluctuate up and
down.
It’s the same when it comes to investing.
Unfortunately, many don’t understand the changing of economic seasons
and therefore fail to adjust the clothing used in their portfolio. As
many saw in 1997-2000 and 2000-2002, the investment clothes that work in
one season are close to useless in another.
There are economic business cycles. There are
seasons when the economy is expanding, other’s when it is contracting.
There are also times (called peaks and troughs) that are like spring and
fall - times of transition from one major cycle to the other.
Interest rates are one key in determining where we
are in that cycle. The Federal Reserve uses the rate it charges on over
night loans to banks (the Fed Funds rate) as an accelerator or brake on
the economy.
It may seem strange that small changes in the over
night rate banks pay could have an impact on the overall economy. Banks
lend more money then they receive in deposits. That ‘extra’ money comes
from inter-bank loans and is referred to as the Fed Funds Market. It
stands to reason that if a bank pays more on what it borrows, it will
have to earn more on what it lends.
The Federal Reserve controls the Fed Funds rate by
putting money into the inter-bank loan market or by taking it out. Just
as supply and demand causes the price of a stock to go up or down, so is
the interest rate charged in the Fed Funds market. By putting money in
or taking money out the Federal Reserve is able to artificially control
the supply demand balance.
Interest rates affect every area of our economy. If
you have to pay a higher interest rate on a mortgage your monthly
payment is going to be higher. Since you can only afford to spend so
much a month on that payment, the interest rate affects the how much
home you can afford.
Likewise, most businesses borrow money to fund
expansion, cover inventory and to smooth out cash-flow. Just like the
homeowner, they have a limited amount they can afford in payments each
month. The amount they borrow affects whether they can build bigger
plants, buy more computers or hire additional employees.
Different industries do well in different parts of
the economic cycle. The construction industry will perform best during
periods of low interest rates because low interest rates are designed to
spur growth. When people and businesses can borrow at low rates they
will build new homes, skyscrapers and factories.
Similarly, we each tend to buy the same amount of
toothpaste and toilet paper regardless of where interest rates are. The
companies that make those essentials aren’t going to see the big change
in demand for their product that a construction company might.
Equity investments can be categorized as cyclical
or non-cyclical based on how they are affected by changes in the
economic cycle. The proportion of each in a portfolio will greatly
affect the overall volatility.
I recommend having a portfolio of high-quality
non-cyclical companies. You can then introduce cyclical companies as the
seasons change to add additional growth. Make sure you adjust the
cyclicals as the seasons change.
Economic cycles don’t just affect stocks. They
determine whether it is a good time to own bonds, and what type of bonds
to own, as well. The last several years, interest rates have been at
historic lows. You don’t want to lock in low rates for 30 years. When
interest rates are above the historic norms, that’s when you want to
stretch out your maturities.
Think of your investment portfolio as a living,
breathing entity. Recognize that the investments used in it will
determine your comfort level as the economic seasons change. Doing so
properly will allow you to increase your return while reducing your
risk. Take advantage of economic cycles. Don’t let them take advantage
of you.
If you have a specific question or would like more
information, give me a call toll-free at 1-877-827-1463 or you can also reach me by email at
jeff@guardingyourwealth.com.
I will answer your financial question FREE.
About Guarding Your Wealth:
“Guarding Your Wealth” is a
nationally syndicated weekly personal finance column written by Jeffrey
D. Voudrie, CFP. Mr. Voudrie is the President of Legacy Planning Group,
a private wealth management firm that employs sophisticated proprietary
strategies designed to protect and grow its clients' investments. Visit his website,
www.guardingyourwealth.com to read past articles under the Guarding
Your Wealth Article Archive that may not have appeared in
SeniorJournal.com.
Guarding Your Wealth for Seniors, on
SeniorJournal.com, is
a collection of columns by Voudrie that deal with issues of particular
interest to senior citizens.
Click here
for all columns.
In addition to being a nationally
syndicated columnist and Certified Financial Planning Practitioner, Mr.
Voudrie provides personal, private money management services to select
private clients
nationwide.
Looking for an energetic expert who
is passionate about financial and wealth management? Mr. Voudrie is an
excellent speaker who will excite and inspire your audience. Mr. Voudrie
is available for a limited number of speaking engagements, television
appearances and radio talk shows. For bookings, email
jeff@guardingyourwealth.com.
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