Wealth Planning
Interest rates are going up. What should you do now?
As the landscape for investing and borrowing changes, review what you own, owe and ought to give away.
Now is a good time to take stock of your assets and liabilities—as well as the time horizon for your financial priorities.
With interest rates heading up, the days of record-low-cost capital and historic asset appreciation have likely ended. So, it’s wise to make sure your financial plans will remain on track—especially if you plan to make a major purchase, invest in a business, enhance your legacy or take other significant action this year.
Already, many rates are higher than they were before the start of the global pandemic in 2020. Most notably, national average mortgage rates are above 4%.
The Federal Reserve has shifted its focus from keeping the economy stable to curbing inflation. Financial markets have priced in as many as six rate hikes this year, with the first having just taken place.
In this environment, financial decision making needs to become more strategic; more intentional. And as higher interest rates force up hurdle rates,1 asset quality will become more important than ever.
Your J.P. Morgan team can help you pinpoint actions you may want to take. Meanwhile, here are some ideas to help you get started across your financial life: banking, investing, borrowing and planning.
What adjustments might you make to your investing and banking?
As yields move higher:
- Rethink your liquidity position(s). When interest rates approached zero, there was little advantage to moving cash into CDs, deposits and core fixed income. That’s no longer the case. Knowing when you will need liquidity can help you invest more efficiently along the yield curve.
- Remember “the 40.” A 60/40 ratio of equities to fixed income investments has long been the model portfolio for individual investors. In recent years, however, fixed income did not provide a powerful buffer against equity volatility—its traditional role. This scenario is changing as rates rise. Here is our latest thinking on fixed income.
- Optimize your equity allocation. Rates tend to rise as we progress through the business cycle. Given where we think we are now, it makes sense to focus on quality companies with strong balance sheets and sustainable earnings. Knowing what you own is going to matter more than ever, and using active managers could potentially reduce volatility and lead to outperformance.
How might you adjust your borrowing?
By historical standards, borrowing rates are still relatively low. However, you may want to review the rate and structure of any existing loan agreements to see whether or not they remain aligned with your longer-term objectives.
For existing debt:
- Maintain floating-rate loans. Given that the market is already pricing in a rate-hiking cycle this year, there’s likely no benefit to fixing the rate now, unless you believe rates will climb higher than current predictions.
- Consider refinancing mortgages or other fixed-rate loans. If you refinanced in recent years, probably no further action is needed. If you haven’t, or if your loan rate will reset in the not-too-distant future, carefully weigh the associated costs of making a change. Ask your J.P. Morgan team about our latest interest rate outlook.
Before taking on new debt, be clear about what you’re trying to achieve:
- Bridge a liquidity gap. The benefit of having financial flexibility likely will outweigh the marginal cost increase in borrowing rates, especially if you are expecting an inflow of cash or want to separate a liquidity decision (Do I need cash now?) from an investment decision (What should I sell to raise funds?). A bridge loan can be a great tool for managing capital calls, large unexpected purchases, taxes, etc.—thereby essentially allowing you to seamlessly manage your financial life without having to keep excess cash on the sidelines for such purposes.
- Leverage an investment position. With borrowing rates moving higher and markets now squarely in mid-cycle, carefully assess whether or not your investment will earn more than it costs to borrow within your given timeframe. Also, make sure your collateral won’t be vulnerable to a capital call at the wrong time. Real estate—specifically unencumbered or significantly appreciated property—is often a stable source of liquidity. Moreover, if the loan is structured appropriately (i.e., treated as investment rather than as mortgage interest), the interest can be fully deductible. In a higher-rate environment, proper structuring of debt can lower your effective borrowing rate.
How could higher rates impact your wealth transfer plans?
If you plan to implement one or more wealth transfer techniques this year, it’s important to understand the potential impact of rising interest rates:
- Grantor Retained Annuity Trust (GRAT)—This is an essentially risk-free vehicle that, if successful (i.e., if its assets appreciate at a rate greater than a fixed hurdle rate), would transfer wealth to the next generation free of gift tax.
GRATs are viable in many kinds of markets. With more rate hikes on the horizon, coupled with recent volatility (which may have beaten up a position you think has strong future growth prospects), it makes sense to fund a GRAT sooner rather than later, and to create one with a longer than usual term (e.g., five years instead of two).
The same thought process holds true for Charitable Lead Annuity Trusts (CLATs), which tend to have longer terms (typically, more than 10 years).
- Intra-family loan—Intra-family loans, as well as loans or sales to Irrevocable Grantor Trusts (IGTs), operate conceptually like a GRAT, exploiting the arbitrage between IRS-assumed interest rates and actual returns. For several reasons—including, typically, a lower hurdle rate—such loans can be more tax-efficient than GRATs. But unlike with GRATs, loans pose a greater risk to family wealth if the investments underperform the hurdle rate. If you’ve taken advantage of some of these wealth transfer techniques in the recent past, there’s likely nothing to do at this time.
If you haven’t, or if your note is going to reset in the future, the steps you take (such as whether to refinance or not) should take into account your confidence in the future growth of trust assets and your view on where rates will be at that time.
We can help
Your J.P. Morgan team can help you assess both sides of your balance sheet and prepare for higher interest rates. Reach out to your team to discuss how these strategies might help you reach your goals. For additional ideas, see our Upside to Low Rates.
All market and economic data as of March 2022 and sourced from Bloomberg and FactSet unless otherwise stated.
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