After nearly a decade, interest rates finally appear to be headed upward again. This will change how many individuals approach their investments, both within their taxable accounts as well as their tax-advantaged retirement accounts. While the full range of implications of rising rates remains to be seen, here are some ways that owners of self-directed IRAs might begin to plan for higher rates.
Avoid Long-Term Debt Instruments. Conventional wisdom would state that investors should avoid long-term debt instruments, such as corporate debt with near-term maturity date, and bank CDs of more than a year or two in duration. By focusing on debt instruments with short-term maturities, an investor will be able to reinvest maturing debt into a new short-term instrument with the then-prevailing (and potentially higher) interest rate.
If you choose to invest in debt with a maturity date that’s further out, consider instruments that are convertible or cancellable at your election. By the same token, if you’re currently invested in long-term CDs or debt, you may wish to investigate whether you can redeem your debt early (even though you’d have to pay an early termination penalty) and reinvest the proceeds at a higher rate.
Consider Changes to Real Estate Markets. Rising interest rates will mean that mortgage lenders will be raising their rates as well, making it more expensive for individual to purchase a new home. This may have the effect of driving down real estate prices in certain areas, as potential buyers will be able to borrow less money with the same monthly budgeted payment.
However, the local market conditions in the areas in which you invest are likely to be the biggest single driver of real estate investing, and not rising interest rates. Many markets are continuing to see double-digit price increases every year, so higher rates aren’t likely to lead to lower prices. In short, rising rates shouldn’t be a reason for you to stop looking at potential real estate investments if you’re already so inclined.
Private Mortgages. Furthermore, rising interest rates make more challenging for some prospective new home buyers to obtain mortgage financing through traditional sources. Banks and mortgage companies have already been relatively selective in their lending practices over the past few years, even as the demand for real estate has risen.
You can use your self-directed IRA to make private mortgage loans to lenders who may not be able to get traditional bank financing, and rising interest rates that this type of investment (particularly if you structure your loan as an adjustable rate mortgage) may be attractive for your portfolio.
Private Business Debt. By the same token, rising rates means that private businesses may struggle to obtain traditional financing to help them grow. Making private business loans could provide an income boost to your retirement portfolio.
Whichever way you decide to leverage higher rates with your self-directed IRA, be sure to seek out expert assistance to ensure that all transactions are properly documented.