Scott B. Tiras, CPA, CFP
Scott B. Tiras, CPA, CFP, is president of Tiras Wealth Management, a financial-advisory practice with $2.2 billion in assets under management, Houston. TirasWealth.com
When financial adviser Scott Tiras discusses QE3 with his clients, he’s not helping them plan a transatlantic cruise. He’s explaining how the Federal Reserve’s latest and most aggressive attempt to stimulate the sluggish US economy—called QE3, for quantitative easing version 3—likely will affect their investments, savings and borrowing.
Here’s what he tells them that can help you in your financial planning…
The massive supply of money that the Fed is pumping into the US economy will keep interest rates extremely low on loans, bonds and savings accounts for an extended period—allowing people to borrow money more cheaply but also forcing many people to look to riskier investments such as the stock market for decent returns. The Fed is committed to sticking with its multibillion-dollar bond-buying program as long as it takes to lower unemployment “substantially,” and that could mean several years.
The Fed’s actions will help ensure that the aging bull market in stocks will live on. But I am urging my clients to stick to their long-term portfolio allocations for stocks and resist the temptation to load up on them at this point as stock indexes surge to multiyear highs. Reason: There still are many crosscurrents that could affect the breadth and intensity of the gains and even knock the QE3-fueled stock rally off course.
For example, recessions are spreading through many countries in Europe amid the debt crisis there. That affects economies in other parts of the world, too, and could be a drag on further stock price gains.
In addition, in the US, we are facing massive tax increases and automatic federal spending cuts scheduled to go into effect January 1, 2013. Unless Congress keeps us from careening off this fiscal cliff, banks may be reluctant to lend, consumers to spend and businesses to expand, also hurting the stock market.
Given all these crosscurrents, it seems wise to wait until we see clearer signs that the US economy is moving along a path of sustained growth before we step up our allocation to stocks.
Within a stock portfolio, I’m not ruling out a role for small-cap and other more aggressive stocks, which may have great potential, but I’m emphasizing dividend-paying blue chips—companies with stable balance sheets and lots of cash. Although these large, multinational businesses already have seen significant gains in share prices, their stocks can continue to do well because QE3 gives them the opportunity to keep borrowing at low rates and expand into more global markets. I also think real estate investment trusts (REITs), which invest in commercial properties, will benefit from lower financing rates—and their yields are very attractive now.
In addition to QE3, under which the Fed is buying up $40 billion in mortgage-backed securities every month, the Fed plans to continue an earlier stimulus program, nicknamed Operation Twist, through the end of 2012. That involves swapping $45 billion of short-term US Treasury securities each month for longer-term ones in order to lengthen the average maturity of its overall holdings.
All of this is designed to maintain downward pressure on long-term interest rates and keep already low short-term rates little changed.
In the long run, however, once economic growth does gain traction and unemployment falls, the inflation rate likely will rise and interest rates will start to jump, causing prices on existing bonds and bond funds to drop.
Even though that may be a few years away, it is wise to start taking precautionary steps now. Put at least 10% of your bond portfolio in Treasury Inflation-Protected Securities (TIPS) or a TIPS fund, and avoid long-term bonds. Start by eliminating your long-term (10 years or more) Treasuries and corporate bonds and replacing them with short- and intermediate-term bonds and bond funds from now on.
Although the inflation rate for the past year was just 1.7% (well below the long-term average of 3.24%), the Federal Reserve’s actions and the likelihood of higher inflation some time in the future pushed up the price of gold by 15% from late May through September. Gold prices tend to rise as inflation fears grow.
If you already are a longtime holder of gold, keep it. There’s limited downside because fears of inflation have effectively put a floor under the price, making it unlikely that it will collapse. But for most investors, gold is just too speculative an investment to buy after a big spike.
Note: The price of other commodities such as oil and copper also has historically risen with inflation. But since the returns on those assets are affected by a variety of other factors, such as global supply and demand and economic growth overseas, I am content to get limited exposure by owning shares in a diversified mutual fund that includes oil companies and other commodity-oriented stocks. Example: Columbia Dividend Opportunity R Fund (RSOOX).
Rising prices for the kinds of mortgage-backed securities that the Fed is buying will push down mortgage interest rates. The belief is that banks, with so much extra cash on their balance sheets, will have a greater incentive to issue more mortgage loans, as well as home-equity and car loans, and to lend to businesses that can then expand and hire more employees.
Consumers may find it easier to borrow, whether it’s to buy a car or a house or to refinance an existing home mortgage loan. Interest rates on fixed-rate mortgages (recently averaging 3.4% for 30-year loans and 2.73% for 15 years) will likely dip lower.
The Fed now expects to keep short-term interest rates extremely low through mid-2015. That virtually ensures that the minuscule yields that you currently get on investments such as savings and money-market accounts and certificates of deposit (CDs) will not move up much, if at all, for almost another two-and-a-half years.
If you want a very conservative investment and must have access to your money within the next three years or less, you must accept an annual return in the 1%-to-1.4% range or lower. Retirees looking to manage their cash flows and boost their incomes should consider buying CDs and Treasuries maturing in different years.
For the first few years, invest in CDs, where you can find better rates now than in short-term US Treasuries. As the CDs come due, you can either draw on the cash or reinvest the money at prevailing rates, which may be higher than they are today.
