The Federal Funds Rate
Over the last 6+ months we have been on a roller coaster, except, this time the seat is a little different. The Federal Reserve controls the Federal Funds Rate (rate at which depository institutions pay for overnight borrowings that are uncollateralized), which correlates to what happens to personal borrowing rates, as well as investment reaction. Below is the fed funds rate over the last 4 years and you can see the steady climb from 0.25 up to almost 2.50. However, see that slope start turn turn downward at the end…
On June 19th, the Federal Reserve announced that there is no change in the rate, with all bets that an interest rate cut is coming (the verbiage of interest rate and fed funds rate is used interchangeably). We are now riding down the rollercoaster hill, as the goal was to steadily increase the rate, with 1 or 2 times in 2019. Why is this so weird? Unemployment is low and inflation is essentially non-existent. In that scenario, interest rates typically rise, as these are the signs of a healthy economy.
However, with the announcement today, I am here to tell you what this all means and how it can impact YOUR life. If you have an investment portfolio and are mad that the market keeps rising, with lower rates, this may keep the market trudging upward. Those that have a mortgage or may be looking to buy a house, this will be a mini education lesson, and dividend investors should also pay attention.
Interest Rates and YOUR Investments
You see any correlation yet? As interest rates were steadily rising and more significantly towards the 2nd half of 2018, the stock market followed suit and dropped like a brick. Since the Fed announced no changes to the fed funds rate and provided signs of a rate cut (or two), the market has already taken notice. The stock market is starting to march back upwards to record highs.
In fact, the S&P 500 closed at an all time high on June 20th, the day after the Fed announcement. What do we do as Dividend Investors during these uncertain times?
Keep it simple. Sticking to your strategy is more powerful today, than ever. Stay consistent. I know WE are going to continue to use the Dividend Diplomat Stock Screener when reviewing individual dividend stocks. As an example, my weighted average dividend growth rate still stands at 7.46% and yields 3.46% (my taxable brokerage account). Therefore, even during these times, my portfolio stays consistent and does at it always has. My portfolio continues to pay dividends from the fundamentally sound companies that I own! On top of that, most are continuing their dividend increases as they normally do.
Further, stay invested into the market! Do NOT try to time an entry or exit. This almost never, ever works and there are a billion studies out there that will show you that. Don’t try to play hero ball in this scenario.
Instead, buy when the opportunities fit what you are looking for. For us, those companies are consistent dividend increases, an above average yield, a lower payout ratio and a low price to earnings ratio (than peers and the market). If that criteria fits, then a stock should be purchased; so long as the company is also fundamentally sound.
Lastly, we are in an inverted yield curve scenario. The treasury yield on a 3 month, today, is 2.18% vs. a 10 year treasury at 2.03%. Essentially, there is more risk today than in a longer-term horizon. I give the reason for this due to the insane amount of macro-economic items occurring (think interest rates, a long expansion, tariffs, trade discussions, etc.). However, this also means that you, more than likely, should keep your funds in short-term/highly liquid accounts. Simply because most long-term investment products (think 2, 3, 5 year CDs) will be paying less than what you can earn on the most liquid products. For those that have a greater than 3% on a CD, “Bravo!” to you!
Interest Rates and YOUR Mortgage
When rates decline, banks receive a lower cost to borrow. Typically, this means rates for customers to borrower when purchasing or refinancing a house are lower. This stands true, especially as they compete for YOUR business and loan product.
We saw mortgage rates reach a higher point towards the end of 2018 and early 2019. However, all has changed and from the quote above, the 10-yield treasury is at its lowest since 2017. Further, you noticed that long-term rates are declining. In fact, here is a snip from BankRate.com (On June 19, 2019), and all rates are trending downwards.
Therefore, if you received your mortgage over the last 12-24 months, your rate may be 0.75-1.50 points higher than what the average 30 year is. In fact, the institution that I’m the Controller at, the interest rate for a 30 year mortgage is 3.80%. Guess what? If there is a rate cut in July, at the next committee meeting, this could tredge downward towards the 3.50-3.75% 30 year-mortgage rate territory. 2016 was the last time rates were in that range, see below:
So what can YOU do if you have a fixed rate mortgage? I would recommend the following:
– Review if re-financing makes sense. You may think to re-finance back into a 30-year mortgage (i.e. if you are between years 25 through 30).
– In this case, your payment will undoubtedly be lower. You can allocate the savings (from interest) directly to loan principal, to reduce your maturity date.
– Perform a payback analysis, as you may pay closing costs to re-finance your loan. If the savings does not outweigh your up-front costs, then it probably doesn’t make sense (typically this occurs in lower balance mortgages or if maturity is shorter).
– If you have ~17-25 remaining years (until maturity), it may make sense to look at a 15-year mortgage re-finance. This would reduce the overall cost over that period. Similarly, run the payback period analysis, to ensure it’s worth the up-front costs.
*To note, average closing costs are around $2,000-$3,000 in Ohio, and may vary for your state! There are sites that show the average closing costs per state/geographical area.
If you do NOT have a mortgage and are in the hunt for a house, you may be in luck to borrow at a very low rate. However, real-estate prices have gone up recently, therefore, you may be paying a premium for a house.
Lastly, if you need help to refinance your mortgage, learn more about mortgages and are not sure what to do, send us a message. We will definitely do our best to assist! Also, it helps that I work at a financial institution.
This may be the most data oriented article in a long time with all of those “pretty” graphs out there. The goal is to keep everyone informed and to improve your financial picture. Further, I wanted to shed light on what this information means and the potential options you may have at your disposal.
It wouldn’t be an article if I didn’t say this. You still need to make EVERY DOLLAR COUNT and these wild times are no different. High yields savings accounts are valuable, as you look for investment or re-finance opportunities. Investing in dividend paying stocks continues to be an AMAZING investment and continues to be the fuel to my financial freedom journey. If you have the ability to refinance your loan, at a lower rate, to save money and have more to invest – DO IT. Make it all count baby!
Lastly, I also want to say, “Turn off the NOISE!”. Not all of this does matter, as a dividend investor, you should understand the impact to the companies you own. However, so long as your companies are fundamentally sound and the dividend is safe (growth and current payment), then you should turn off the noise and stick with your strategy.