Where are Interest Rates Headed?


The Federal Reserve met last week. The Fed’s statement at the end of their two day meeting and Chairwoman Janet Yellen’s press conference provides insights regarding the future of interest rates, inflation and the economy.

 The Fed continues to feel that the economy is expanding, but at a moderate pace. The Federal Reserve has a legal dual mandate to strive towards “full employment” and to hold long term inflation at around 2%. The Fed feels inflation is currently below 2% and longer term inflation expectations are “stable.”

 The Fed reaffirmed its current “highly accommodative stance” of very low interest rate levels. Short term interest rates (for maturities under a year) are near zero. They “anticipate” these very low interest rates “likely will be appropriate… for a considerable time (emphasis added) after the (bond) asset purchase program ends…” Their current bond asset purchase program, which is a method the Fed has used to reduce long term interest rates, is expected to conclude at their next meeting, in October, 2014.

 When will short term interest rates begin to rise? What does the Fed mean when they say rates will stay low for a considerable time? The Fed has not provided specific answers. Chairwoman Yellen said this is based on how the economy performs.

 The Fed has provided guidance of their interest rate expectations. Past guidance for short term rates (defined as “the fed funds rate”) were for 1.25% in late 2015 and 2.5% in late 2016. The current projections are between 1.25%-1.50% in late 2015 and 2.75-3.0% in late 2016. While these are helpful, it is important to note that in reviewing past guidance that the Fed has provided, their own predictions have often been inaccurate.

 As current fed funds rates are near zero now, this implies an increase in short term interest rates of approximately 1.5% over the next 15 months and an additional 1.25% – 2% increase in the following year (2016). Compared to where interest rates are today, the Fed is projecting a 3% increase in short term interest rates over the next 24-30 months. This is a significant increase from today. The Fed’s projections for interest rates by the end of 2016 are more aggressive now than they projected in June, 2014.

While the Fed has not stated when short term rates will begin to rise, based on their internal projections, rates are likely to begin rising sometime in the first or second quarter of 2015. As stated above, the Fed said interest rates will remain low for a considerable time. However, based on their internal projections, the Fed’s definition of “considerable time” appears to be much shorter than what most people think that would mean. The Fed appears to be thinking in terms of months, while most people would think considerable time means much longer than that. This is an important distinction to understand.

The Fed expects economic growth to continue to expand, but at a reduced level than they projected in the past. They now project the economy to grow below 3% annually over the next three years. This compares with a 3.4% growth rate during the 1990s.


The Most Important Thing

One of my favorite bloggers and authors, Seth Godin, wrote a short, insightful post on Monday. You can read it here.

Seth wrote that “the next thing you will do today will be the most important thing on your agenda, because, after all, you’re doing it next.”

However, that may not be case. He said that you may do the most urgent or the easiest thing to do.

He concluded: “In fact, the most important thing probably isn’t even on your agenda.”

He makes a great point. What important things are not even on your agenda?

What are you putting off, that should be dealt with?

Are there conversations that you need to have with family members, friends or co-workers?

Have you properly handled your estate planning? Have you updated it recently?

Are there medical appointments or tests that you need to schedule?

Do you have enough money for the retirement you desire?

Will there be enough money saved for your children or grandchildrens’ college education? Have you funded them in the most effective manner?

Have you talked to your family members about your estate plan? Have you ever had a family meeting to talk about next generation financial planning?

Have you told the people that are important to you how much they mean to you? Have you shown gratitude?

Do you have a financial plan of any type? Do you understand the investment philosophy of your financial advisor?

If you own a business or run an organization, have you dealt with succession planning or disaster recovery?

Are you taking care of yourself?

We encourage you to spend some time thinking. Take 5 minutes.

What are the important, but not urgent things in your life that deserve your attention?


How Changing Your Focus Can Make You Happier

The S &P 500 has been up 61 of the last 83 years, since 1930.

     It has been down in 22 of the years since 1930.

Since 1980, the S &P 500 has been up for 27 of the 33 years.

     It has been down in 6 of the years since 1980.

Regardless of whether this broad index of the US stock market rose or declined for the full year, there has been an average decline of over -14% at some point within a year, since 1980.

This means that while the broad US stock market has risen in many years since 1980, on a calendar year basis it may have still incurred a significant decline within that same year.

This is what we call volatility.

This is why we advise you to focus on the long term, not the daily, monthly and quarterly movements of the stock market.

Focusing on the long term will help you to be happier and calmer about the stock market. And most likely, wealthier!

Note and Source: We recommend investing in a much broader, globally diversified portfolio than just the US based S&P 500. This information is for illustrative purposes only. This S&P annual return data was obtained from the DFA Matrix Book.

Keys to Success in Football and Investing

A good game plan, discipline and consistency. These are needed for a winning football team as well as a successful investment experience.

A strong football team is usually led by an outstanding coach, who has developed a set of guiding principles that are followed by his players.

When I was doing the research that led to the formation of our investment firm, I wanted to have a consistent investment philosophy that would guide us for the long term. I didn’t want to rely on fads, trends or crystal balls.

Burton Malkiel was one of the guiding forces in influencing our investment philosophy. He wrote the investment classic A Random Walk Down Wall Street in 1973. The 11th edition will soon be published. What Malkiel wrote over 40 years ago still holds true today. His beliefs have stood the test of time.

When Malkiel talks or writes, people listen (or should listen). Malkiel wrote an Op-Ed in the Wall Street Journal that was published last Thursday, titled “Are Stock Prices Headed for a Fall?” He provided insights and recommendations which are very consistent with the advice we provide to our clients.

Malkiel did not directly answer whether stock prices are heading for a fall. He said that with persistent low interest rates and an environment for slow but steady growth, stock prices should continue to grow over time. We agree with this. His main message was that you should not expect, assume or plan for annual double-digit investment returns. He stressed the importance of savings and realistic return assumptions.

“Second, don’t think you can time the market and sell your stocks now, hoping to get back in later after there is a correction. No one can consistently time the market, and you are more likely to get it wrong than get it right.” Perfectly said!

His next advice: “Stay broadly diversified with a portfolio that is consistent with your age, financial obligations and risk tolerance…All equity portfolios should include emerging markets.”

We have always believed in globally diversified portfolios. We think 30-40% of your stock portfolio should be invested outside the US, for diversification and performance benefits. While emerging markets are quite volatile, we agree with Malkiel’s assertions. Although emerging markets lagged the US markets in 2013, they have outperformed them in 2014. We believe a consistent allocation to emerging markets is an important component of a strong investment portfolio.

Malkiel stated that emerging markets are growing rapidly and represent a significant portion of the world’s economic activity. Malkiel is not making predictions about what will occur in the near term. He is advocating sticking with a globally diversified portfolio for the long-term, which should include an allocation to emerging markets.

Does your portfolio include an allocation to emerging markets?

Are you properly diversified on a global basis?

Do you have a consistent and disciplined investment game plan?

We do. And so should you.