Inflation and Rates on the Rise-Now What?

Stewart H. Welch III

Physician's Money Digest, August15 2004, Volume 11, Issue 15

In June, the Federal Reserve raisedinterest rates 0.25%. This is the firstrate hike in over 4 years and signals abasic shift in the direction of interestrates. The goal of the Federal Reserve isto proactively fend off inflationary pressurescaused by our accelerating economy.One question on everyone's mind ishow fast and how far will the FederalReserve go to put the economy back intofull throttle?

Alan Greenspan has intimated thatthe Federal Reserve intends to move veryslowly and deliberately, but it's safe toassume that the Federal Reserve will ultimatelymove as quickly as necessary tokeep inflation under control.

Loan Control

What does this mean to you? Shouldyou do anything with your money as aresult of this shift in the direction ofinterest rates? If you have variable interestrate debt, here are some strategiesfor you to consider:

If you have an adjustable rate mortgageor Equity Line of Credit, considerrefinancing to a fixed rate while ratesare still relatively low. Current fixed-ratemortgages for a conventional loan are aslow as 5.75% for a 15-year loan.

If you're holding cash, considerusing it to pay off variable rate loans.Use an equity line of credit as an emergencyreserve instead of cash.

Many credit card companies continueto offer teaser rates to entice newcustomers to move their balances. Youmay want to take advantage of theseoffers, but be aware that too manymoves may hurt your credit score andhurt your chances for obtaining newcredit. Use bonuses and any extra cash toreduce balances.

  • If you have two or more studentloans, consider consolidating them into anew long-term, fixed-rate student loan.You are allowed to do this only once,and now is the time to take advantageof this while the fixed rate is still a bargain.Go to www.loanconsolidation.ed.gov for more information.

Market Response

Rising rates typically spell trouble forbond funds as bond prices fall. If youown a bond mutual fund, considerwhether you should continue to own it.Bond fund values are likely to continueto erode over the next several years.

Many people worry about the effectrising interest rates will have on the stockmarket. Assuming a slow and steadyincrease, historically, the stock marketdoes well. This is because the FederalReserve action is a result of trying to slowdown an increasingly robust economy. Inother words, company earnings areimproving significantly, which usuallytranslates into higher stock prices. If interestrates soar too high or the FederalReserve raises rates too fast, the economycan flounder and the stock market willfollow. Alan Greenspan appears committedto avoiding this result.

This change of direction by the FederalReserve is important. Individual physician-investorsneed to take a moment to assessthe impact on their personal finances. Anold Wall Street slogan is "Don't fight thefed." There is good reason to believe thevalidity of this slogan.

Stewart H. Welch III, CFP®, AEP,founder of The Welch Group, hasbeen rated one of the nation's topfinancial advisors by Money andWorth. He welcomes questions orcomments from readers at 800-709-7100 or www.welchgroup.com. Reprintedwith permission from the Birmingham PostHerald. My thanks to Hugh Smith, CPA, CFP®,for his substantial assistance with the preparationof this article. Mr. Smith is a senior financial advisorwith The Welch Group, LLC.