How to Succeed in a High-interest Rate Environment

A high-interest rate environment can have different implications for investors depending on how they position their assets. For those holding fixed-income investments such as bonds or certificates of deposit (CDs), rising interest rates can mean higher returns, boosting cash flow.

On the other hand, those looking to secure debt — for example, to finance a home — are in for a challenge. In 2021, the average rate for a 30-year mortgage was 2.96%. That figure soared to 5.34% in 2022 and through the early months of 2023, rates have fluctuated between 6 and 7%.

While we cannot know precisely where the economy is headed, there are steps that investors can take to ensure their money is working hard for them. In a recent episode of Passive Income Pilots, hosts Tait Duryea and Ryan Gibson discussed the climbing interest rates and unpacked strategies for staying ahead.

Here are five key takeaways:

How Did We Get Here? It’s Complicated

Since 2020, we have experienced significant geopolitical conflict, a pandemic, major supply chain disruption and record inflation. At the end of 2021, the overnight borrowing costs were close to 0%, and purchasing power was high. This was driving up demand for assets like property.

To combat this, the Fed announced that it would be raising interest rates. At the time, most financial commentators predicted 1-1.5% increases. In fact, today’s federal funds rate sits between 4.5 and 5%.

All things considered, the relative stability of the current landscape is a testament to the resilience of our economy. Whether or not the Fed can achieve a “soft landing” — whereby the economy slows down enough to drop to the target interest rate of 2% while avoiding a recession — remains to be seen.

If You Don’t Invest, You’re Losing Money

While high-interest rates are challenging for borrowers, they can be a goldmine for investors. The cost of debt is up, but so are the returns on products such as high-yield savings accounts and CDs.

With news of the Silicon Valley Bank and Signature Bank collapses still top of mind, banks are actively courting deposits, and many are willing to pay highly competitive interest rates — often upwards of 4%. 

Contrast that with an investor keeping excess cash in a 0% checking account. They could be leaving money on the table simply by failing to take advantage of the opportunities available to them.

The Yield Curve is Inverted

We have navigated high-interest rate environments before. What makes this moment unique is the state of the yield curve.

Yield curves plot the relationship between interest rates and maturity dates of a particular asset. A “normal” yield curve is upward-sloping, meaning that longer-maturity bonds offer a higher yield when compared to shorter-term bonds. However, the current yield curve is inverted, meaning that interest rates for long-term bonds are lower than those for their short-term counterparts.

The same is true in the CD market. Consequently, investors shopping for CDs are likely to find much more favorable interest rates on three-month CDs than they might on a five-year deal.

Investors are used to navigating the “normal” yield curve and expect to sacrifice liquidity for higher returns. For now, that relationship has been turned on its head. As a result, vehicles like debt funds — which offer a high yield on a longer time frame — could be a more attractive option than a CD.

Don’t Overlook Arbitrage

With rates on the rise, interest arbitrage can be a powerful tool to help investors get the most out of their money. American households owe a total of $16.5 trillion in debt, and the average U.S. household has a debt balance of $165,000. For many, paying off debt — especially mortgage debt — is a core financial goal. Yet making aggressive early payments could actually hold borrowers back.

Interest arbitrage is a strategy where investors simultaneously balance assets and debt to drive a profit. Millions of Americans refinanced their homes over the past two years, securing 2-3% interest rates. For those holding low-interest debt, paying over their monthly payment may not be the most effective use of income. Suppose a mortgage note is at 3%. If the mortgage holder can earn more than that with their investments, they will ultimately derive the most value by maintaining the debt and leveraging their money elsewhere.

Pay Yourself First

A high-interest rate environment provides a unique opportunity to build wealth. As such, a “pay yourself first” philosophy can prove particularly fruitful.

By participating in a high-yield opportunity such as a debt fund, investors can leverage their earned income to generate a new source of cash flow. They can then use that money to support regular expenses, be it a luxury, like a car, or a necessity, like their mortgage payment. Or they can reinvest to augment their returns further.

Want to learn more about how investing in debt can help you to get ahead in a high-interest rate environment? The Spartan team recently walked through the benefits of the Spartan Storage Debt Fund in a fireside chat. Watch the session below.

Spartan does not give tax, legal or investment advice. Please seek outside counsel from your CPA or attorney before making any tax, legal or investment decisions.