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How “Higher for Longer” Interest Rates Can Impact Your Investments

Doug Kronk • May 02, 2024

The stock market has had a rough ride this past month. The S&P 500 index closed out April at 5035.69, down over 200 points (-4.2%) since the close of March. Investors have become pessimistic and frustrated, and it’s largely because the deep interest-rate cuts that the market expected early in the year just aren’t materializing. 


The “good news” coming out of the Fed’s May 1 meeting was that Chairman Powell didn’t see any new rate INCREASES on the horizon. While there will certainly be opportunities to make money in a high interest rate stock market, investors would be well-served to evaluate their holdings and potentially make some changes.

The Federal Reserve started raising rates over two years ago in March of 2022 as it became clear that runaway inflation was not transitory as first thought, and the problem was not going to fix itself. By July of 2023 short-term interest rates had gone from close to 0% to over 5%, where they have essentially stayed since. Despite a slowing of inflation, it still stubbornly remains above the Fed’s 2% inflation target.


Currently, the market’s interest-rate cuts expectations have evaporated: Instead of the six quarter-point rate cuts expected earlier this year, the consensus now is that only one or two cuts will occur this year. Personally, I believe there’s at least a 50% chance we don't see any rate cuts from the Fed this year.


Operating under this assumption, here are a few things to watch for. First, the housing market will likely continue to be murky at best. The average interest rate on a 30-year mortgage is 7.5%, the highest level in two decades. That’s causing current homeowners to stay in their homes financed at lower rates rather than move into other homes with higher mortgage rates. This creates a domino effect as it limits available inventory for first-time home buyers that have essentially been priced out of the market. Reduced inventory, turnover, and new home starts are hitting companies that provide housing materials and build homes hard. When interest rates are high, that’s generally a sector of the market to avoid, and it’s part of why the economy in general could struggle in the next few months.

Another sector that is likely to be hit hard by a higher-for-longer environment is small-cap stocks. Smaller companies need to borrow capital to grow, and higher costs of capital push their profitability lower. Consequently, many are forced to put growth plans on hold. Additionally, elevated inflation usually hits consumer-discretionary industries. Americans could rein in their vacation travel, for instance, hurting companies in related businesses.


I also suggest exercising caution and selectivity with regards to corporate bonds in a high-rate environment. Many debt-laden companies, faced with higher rates, run a greater risk of default than I believe the market truly appreciates.


So, where can opportunities be found in a “higher for longer” interest rate environment? A good place to look is companies that have low levels of debt, have increasing sales, and that have the cash to purchase distressed companies. Some of the biggest and best-know technology companies have billions of dollars of cash available, and as small companies wrestle with high-interest debt, many have become targets rip for acquisition.

As always, choosing the right mix of investments depends on your goals, your timeline and your comfort level with risk. Don’t hesitate to get in touch with us if you’d like to discuss your investment portfolio.

Trusts and Tax Rates: Some Notable Considerations

By Doug Kronk • 04 Apr, 2024
Trusts are a legal entity that is commonly used to hold assets for future distribution or management purposes. For example, it is common for some families to create a trust to fund their children’s college education, contributing funds that the children can later withdraw to pay their college expenses while going to school. It is also common to place the family home and assets into a trust that will own the property, potentially indefinitely, to ensure the home, its furnishings, and additional assets always stay within the family. Trusts and taxes can become very complicated, however. To be certain that you make good decisions, it is advisable that you work with a team that specializes in this area to help clarify relevant issues, such as a financial advisor, CPA, and an attorney. 

SECURE 2.0 Adds New Life to College 529 Plans

By Doug Kronk • 01 Mar, 2024
College-savings plans known as 529 plans have become increasingly popular since being introduced in 1996, primarily due to the benefits of accumulating funds for college expenses tax-advantaged. However, despite the attractive tax benefits, many savers have balked at the use of a 529 plan because of one very nagging question: What happens to the funds that aren’t spent for college? All 529 plan funds can only be used on eligible expenses, such as room and board, books, supplies, technology, and private K-12 tuition. How to deal with unused funds has always been a tricky proposition. Funds could be saved for graduate school, transferred to another family member’s 529 plan, or the beneficiary of the plan could be changed. Getting unused funds back was not an attractive option, however, as this would likely incur a 10% penalty as well as make the investment gains subject to federal income tax at whatever rate the IRS would normally charge! Fortunately, thanks to SECURE 2.0 Act of 2022, the rules have finally changed, and, in my humble opinion, the changes make 529 plans a lot more appealing than in the past. Under the new rules, up to $35,000 can be rolled from a 529 plan into the beneficiary’s Roth IRA account. Despite college costs rising faster than inflation in general, it’s still quite common for beneficiaries to not use all of the funds in their 529 plan for undergraduate, graduate, or trade school. Many beneficiaries are fortunate enough to get scholarships or grants. Others decide to attend less-costly schools than originally planned. Some may decide to skip college altogether or join the military and use the educational benefits offered by the Departments of Defense or Veteran’s Affairs. Whatever the reason, many end up with unused funds in their accounts, and now these beneficiaries can use these funds to get a jumpstart on retirement savings by rolling these funds into a Roth IRA. If the 529 plan was started when the beneficiary was quite young, the power of compounding over several decades can build a very significant part of what will be their retirement nest egg. By removing the previously mentioned negative obstacles regarding what to do with unused funds, SECURE 2.0 has created a desirable avenue to help save for retirement as well as pay for higher education, but there is a catch. While 529 account owners/beneficiaries can roll up to $35,000 into a Roth IRA, it can’t be done all at once. Annual contributions are limited. For 2024, the annual contribution limit is $7,000 for those under 50 years old, and $8,000 for those 50 years old and older. Another benefit of the new rule is that those who would normally be ineligible to contribute to a Roth IRA because of income limits are still eligible to contribute to a Roth IRA by rolling over unused 529 plan funds. So, how would this work in a practical sense? Let’s assume that Lisa has $35,000 of unused funds in her 529 when she finishes graduate school at age 24. Assuming that Lisa begins rolling those funds into a Roth IRA at the rate of $7,000 per year, she will be 29 years old when she has rolled all $35,000 into her Roth IRA. Further assuming an annual growth rate of 8%, the Roth IRA will have approximately $51,500 in it when Lisa is 29. If Lisa continues to earn 8% annually, and retires at 65, she will have over $820,000 of tax-free retirement savings in her Roth IRA WITHOUT EVER HAVING MADE ANOTHER SINGLE CONTRIBUTION TO HER ROTH IRA! That is the power of compounding over time. As always, there are caveats and other factors to consider, but these are all on a case-by-case basis. Your individual circumstances are likely different from the hypothetical case for Lisa, but the general concept is still the same. The bottom line, however, is that the new rollover rules, and the power of compounding, have just added new life to 529 plans, making them a lot more attractive than they used to be. Please reach out to us if you’d like to learn more.
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