Tariffs, Interest Rates & Your Retirement Account

Valley Sentinel – July Issue

Last month I wrote about the potential impact that rising mortgage rates and lower tax deductions could have on local real estate (if you missed that article and would like a copy just send me an email).

This month I would like to provide a similar cautionary guide on what tariffs and interest rates could do to your retirement account.

Let’s start with tariffs and a possible trade war. While economists differ on how much blame the Smoot-Hawley tariffs deserve for the Great Depression, the stock market was clear in its reaction. The Dow Jones Industrial Average was around 340 just before the House passed the bill. In short order, the Dow dropped down all the way to around 50 before FDR was elected and stocks started recovering. Now again, we cannot be sure what percentage of this 85% decline in the stock market is attributable to tariffs, but there is reason to believe that the stock market doesn’t like tariffs and if a trade war does take place, it could at least temporarily sink the stock market.

Now let’s talk about interest rates. As you may have discovered, the investment community and the financial media talk a lot about interest rates and for good reason. When the banks make borrowing more expensive, companies tend not to borrow as much and pay higher rates of interest on existing loans (if the rates are variable, which they often are). This means less business spending which in turn means less growth for the company. If this reduction in growth leads to a decrease in profits then the stock price usually takes a hit.

The really bad news here is that rising interest rates are also bad for bonds. The math here is complex but think about it this way, if newly issued bonds are paying 4% interest and the bond you own is paying 3% interest, I would only buy your bond if you discounted the price to make up for the 1% of lower interest I am earning. That discount is reflected immediately in the value of existing bonds. As proof of this concept playing out in real life, just look at the Vanguard Long-Term Treasury Bond Fund (ticker VUSUX) which had two 10%+ declines in the past few years (2009 & 2013).

Every week I talk to investors who are “making no changes” because their portfolios have worked for the past few years and therefore “if it ain’t broke don’t fix it”. However, the environment may change radically in these two areas and all of a sudden what has worked will stop working. After the run-up in stocks over these past 9 years, it’s easy to forget that between the start of 2000 and the end of 2009 stocks had a rate of return of basically 0%. I am not sure most people’s retirement plans could survive on those types of returns.

If you want a second opinion on your retirement & investment accounts, give us a call at 925-927-1900 or email me at rob@swrpteam.com.

Robert Cucchiaro is a Certified Financial Planner and owner of Summit Wealth & Retirement, a financial planning firm that has been serving Danville for over 30 years. Summit Wealth has 3 Certified Financial Planners (CFP®), a Chartered Financial Analyst (CFA), an MBA and a Tax Director (EA) all on staff and in Danville. Visit us at www.summitwealthandretirement.com