After a recession that has seen millions lose their jobs and has cost investors trillions of dollars, the early signs of recovery that have appeared in recent months have nearly everyone hoping for economic growth.
Investors, though, need to remember that the end of the recession will change the environment they've lived with for years now. As a result, you'll want to make some financial moves to take maximum advantage of a better economy.
Be ready for rising rates
In particular, a stronger economy will inevitably put upward pressure on interest rates. Although Fed chairman Ben Bernanke has said repeatedly that the Fed doesn't plan to tighten monetary policy prematurely, a strong recovery will inevitably create inflationary pressures that will force the Fed's hand.
Higher rates will have major implications, both for your personal finances and for some of the investments you make. So rather than expecting today's low rates to last forever, take a look at these three courses of action, and make sure you're ready for what's coming.
1. Lock in low rates on debt.
Right now, interest rates on loans are as attractive as they've been in years. Mortgage rates are again near historic lows, with 30-year mortgages averaging just more than 5%. Compare that to 2007, when rates were nearly 1.5 percentage points higher, and you'll see just how cheap mortgage loans are.
When rates rise, though, those cheap mortgages will disappear in a hurry, and you can also expect to pay more on everything from credit card debt to car loans. So, while the days of using ever-increasing home equity to finance a lavish lifestyle are over, anyone who still has a high-rate mortgage should take every step possible to refinance to a lower rate.
2. Keep your cash liquid.
The situation is much different for savers. Those with money in the bank have seen rates on one-year CDs fall from more than 5% in 2007 to less than 2% today. Even those willing to commit their money for longer periods of time aren't seeing big rewards; the average five-year CD yields just 2.87%. And even the top deals from institutions like the bank units of Discover Financial (NYSE: DFS ) and AIG (NYSE: AIG ) can't break the 3.5% level on a five-year CD.
If interest rates rise, you'll regret having locked up your money in a long-term CD. Right now, you're not getting enough extra return to justify the risk of seeing rates go up. If you invest in shorter-term CDs, or even bank savings accounts, you may earn less money now, but you'll be in a position to reap the benefits of higher rates immediately when they come.
3. Watch out for rate-sensitive stocks.
Interest rates don't just affect fixed-income investments. They can also have a big impact on the stocks you own.
For example, some stocks are particularly sensitive to rising interest rates. Banks like Wells Fargo (NYSE: WFC ) and US Bancorp (NYSE: USB ) earn much of their profits from the spread between the rates they pay on deposit accounts versus what they make from long-term loans. So, if short-term rates rise without a corresponding increase in longer-term rates, then that spread narrows, hurting profit margins.
In this particular recession, though, some traditionally rate-sensitive areas may still do well. Homebuilders like Toll Brothers (NYSE: TOL ) and Pulte (NYSE: PHM ) would normally do badly when interest rates rise because mortgages become less affordable to prospective buyers. But because the housing business has taken such a big hit during the recession, an improving economy could more than offset that negative impact.
Finally, watch how companies are handling their own debt. Those with a lot of debt, especially floating-rate debt, could be vulnerable to higher interest costs from rising rates. On the other hand, companies that are taking steps to lock in financing at low rates by issuing fixed-rate bonds, as even cash-rich Microsoft (Nasdaq: MSFT ) did earlier this year, are making exactly the right move in anticipation of rising rates.
Higher rates may not come in the next few months. But eventually, you'll have to deal with a rising rate environment. How you prepare now for that eventuality could define your financial success for years to come.
Think a recovery's a sure thing? Matt Koppenheffer is ready to rain on your parade with his pessimistic predictions on the economy.