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New Rules for Success

Jonathan Clements

FOUR DECADES OF falling inflation and declining interest rates have come to an abrupt halt—and that’s changed the calculus on a fistful of financial decisions.

Want to make smarter money choices in the months and years ahead? Here are seven new rules for financial success:

1. Carrying debt is less foolish—in some cases. Thanks to inflation, families can now repay the money they’ve borrowed with depreciated dollars. That won’t help you with credit card debt, where interest rates have soared along with inflation, thus ensuring that carrying a card balance continues to be the height of financial foolishness.

But if you have a fixed-rate mortgage from before 2022 or a low-interest car loan, your debt is shrinking rapidly in inflation-adjusted terms, thanks to the 7.7% spike in the Consumer Price Index over the past 12 months. The implication: Don’t rush to rid yourself of these debts.

2. Buying bonds beats paying down older mortgages. I’ve long been an advocate of paying down debt, including mortgage debt, because the interest rate owed was usually higher than the interest rate you could earn by buying high-quality bonds.

But that’s likely not true for anyone who took out a mortgage before 2022. Got a fixed-rate mortgage that’s costing you 3%? Now that 10-year Treasury notes are yielding 3.7%, up from 1.5% at year-end 2021, and corporates are paying even more, you’re probably better off buying high-quality bonds than prepaying your mortgage. What if you took out a mortgage this year, which might be costing you 6% to 7% in interest? Making extra-principal payments is still a smart strategy.

3. Asset location matters once again. When bond yields dropped to minuscule levels in 2020, some financial experts noted that holding taxable bonds in a regular taxable account was no longer a problem, because the tax owed on the interest received would be tiny. But with bond yields climbing along with inflation, it’s time once again to keep your bonds—except for municipals, of course—in a retirement account, so you don’t have to pay income taxes each year on the interest you earn.

4. Extending bond maturities is more appealing. For the bond portion of my portfolio, I’ve long stuck with a mix of short-term conventional and inflation-indexed government bonds. But I’m toying with shifting some money into intermediate-term bonds.

To be sure, the yield curve remains inverted, with two-year Treasury notes kicking off more interest than 10-year Treasurys. That’s prompted some folks to declare that “cash is no longer trash” and that the place to be is money market funds, Treasury bills and short-term certificates of deposit. Problem is, today’s high short-term rates may prove fleeting.

Whenever the Federal Reserve decides inflation is under control or that the bigger threat is a recession, it’ll start cutting short-term interest rates. Result: Today’s handsome cash yields will disappear. Investors might imagine they can shift into bonds at that juncture—but, by then, intermediate- and longer-term yields will likely also have dropped. The upshot: If you want to lock in today’s more generous yields, consider swapping your cash for intermediate-term bonds in the months ahead.

5. Bonds again offer the chance to beat inflation. We can’t know for sure what will happen with interest rates and inflation over the next few years. But we do know it’s now possible to outpace inflation with bonds—if you purchase inflation-indexed Treasury bonds and Series I savings bonds.

Today, 10-year inflation-indexed Treasurys are paying 1.4% more than inflation, while Series I bonds are currently offering 0.4% above inflation. By contrast, until recently, Series I savings bonds offered no interest over and above inflation, while inflation-indexed Treasurys sported a negative after-inflation yield.

6. Selling a home has become costlier. It isn’t simply that you might need to slash your asking price to find a buyer amid today’s much higher mortgage rates. On top of that, if you have a mortgage, selling and then buying could mean both giving up your current low-interest-rate mortgage and taking on a much higher-rate mortgage to purchase the new place.

7. Future profits are less valuable. As interest rates have climbed, banking on the distant future has lost its appeal. Risking money on an investment that might not pay off for 10 or 20 years—and might never pay off—may have seemed okay when bonds barely yielded 1%. But now that you can pocket a 5%-plus yield on many high-quality bonds, a high-risk investment has to be awfully compelling to attract investors.

Result? Goodbye, cryptocurrencies and nonfungible tokens. What about growth stocks? Their potential for hefty corporate earnings down the road now seems like a more distant promise—and one that might be broken. By contrast, value stocks, with their healthy current earnings and often high dividend yields, have become far more appealing. After all, why speculate on the future when you can collect a handsome dividend check today?

Jonathan Clements is the founder and editor of HumbleDollar. Follow him on Twitter @ClementsMoney and on Facebook, and check out his earlier articles.

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johny
johny
2 months ago

Jonathan,

i have been following you for years and years.

While i contemplate all the things I am thankful for, it has become obvious that you deserve my sincere thanks for the many years of speaking sense to those of us weak-willed investors and keeping us on the long and narrow road to financial independence.

Though you aren’t number one on my list – that belongs to Mr. John Bogle, to which I am sure you agree – you are easily in the top three of my favorite investing gurus accessible to people of Main St.

So thank you Mr Bogle in Heaven and Jonathan somewhere in PA/NJ !!

Last edited 2 months ago by johny
Jonathan Clements
Admin
Jonathan Clements
2 months ago
Reply to  johny

Thanks for the kind words! I’m happy just to be mentioned in the same sentence as Jack.

John Wood
John Wood
2 months ago

While you correctly referenced “older mortgages” in point No. 2, Jonathan, I think it worth noting that paying down the mortgage on a relatively newer mortgage is still beneficial.

Using your interest rates above (3% mortgage vs. 3.7% Treasury), assume one took out a 30-Year, $500,000 mortgage in November of 2021, and is about to make their 13th mortgage payment of $2,108 (Principal and Interest). Further assume a choice of buying three 10-year Treasury bonds for $3,000, or paying down the mortgage with that $3,000.

The $3,000 bond buy at 3.7% would yield $111 in annual interest, or a 10-year interest return of $1,110.

The $3,000 extra principal payment would eliminate 3 monthly payments (and $334 of the 4th), and save $3,992 in mortgage interest.

Avoiding the hair splitting (i.e. the effect of taxes, reinvestment opportunities and risks, more principal paid on future payments, etc.), the point, I believe, is that the interest is so front loaded in the early years of a mortgage, that a comparison of nominal mortgage and bond rates can be misleading.

I think the key factor is how many years into the mortgage one is.

Jonathan Clements
Admin
Jonathan Clements
2 months ago
Reply to  John Wood

I hate to say it, but I disagree! What counts is a comparison of the interest rate, not the amount of a payment that’s going to principal vs. interest. Whether you’re in year one or year 10, if a mortgage is costing you 3%, that’s the interest savings you enjoy by making extra-principal payments.

Boomerst3
Boomerst3
2 months ago

One is probably better off having a mix of growth and value stocks in their portfolio. Moving from growth to value because you thing they are broken is like trying to time the market. The way the American consumer spends, the future should be good for growth stocks as well as value.

‘In keeping with the theme of large caps’ dominance, you can see in the next chart that S&P 500 Growth has outperformed S&P 500 Value by nearly 500% since 1995 (the inception of the latter index)—a decline from the peak of more than 700% but still a strong spread over the long term.’

Gozo Rabat
Gozo Rabat
2 months ago
Reply to  Boomerst3

I personally respect your comparison of “moving from growth to value” as a variety of timing.

As to the other elements of your point, I’m unqualified to judge.

Regards,
(($; -)}™
Gozo

johny
johny
2 months ago

Jonathan,

regarding bullet 3, if one is close to or in retirement, wouldn’t having intermediate bond funds in a taxable account be fine since one would be living on the interest?

I have a municipal bond fund which I am thinking of converting to an intermediate bond index fund now when yields are still attractive.

Last edited 2 months ago by johny
Jonathan Clements
Admin
Jonathan Clements
2 months ago
Reply to  johny

If you’re spending the interest, keeping the bond fund in a taxable account would indeed be fine. But if your goal is to defer gains, the retirement account is the way to go.

David Kirschner
David Kirschner
2 months ago

All good points to consider. I’ve found since recently retiring, many “rules” may not be the best path in all cases. E.G. #3 Asset location. Conventional wisdom calls for fixed income investments to be in tax deferred accounts and therefore only equities in after-tax. This certainly makes sense during accumulation phase. However, for retirees managing the “gap period” to SS, generating fixed income in after-tax accounts (to the top of a desired tax bracket) to be a comfortable way to generate predictable income. Thank you for the article, You covered a number of broad areas to consider.

James Kerr
James Kerr
2 months ago

Very informative article. Thanks for writing it, Jonathan. We are definitely in a new age right now. The easy money is gone and now we’re going to have to earn it the old-fashioned way. While I got rid of my mortgage before I retired from the corporate world, I look back longingly now at the days when I had a 3% mortgage. Boy, I would jump at that again.

Gozo Rabat
Gozo Rabat
2 months ago
Reply to  James Kerr

FWIW, we sold one large property (that took a lot of time and work, and had appreciated far beyond our expectations) and used most of the proceeds to pay off all our other mortgages, despite how low the interest rates were.

On a dollar-for-dollar exchange, this was clearly not the best way to go: paying off the once-in-a-lifetime, low rates, when one-year CD rates are now already above the 4.70% rate.

On a basis of no longer having the mortgages themselves to deal with, I can’t speak highly enough of our relief.

Most of retirement literature seems focused on a somewhat-precise number, despite that we all know no such “precise number” is likely to obtain. Instead, my household always aimed high above any such figure, so that we should have more than enough assets for retirement, baring a complete meltdown of our American society. (Hey! Don’t scoff! It could happen!)

Our American financial world, for the most part, focuses so-much on what strike me as a wrong way of looking at money, in general, and at retirement, in particular. Happily, we have all had Jonathan Clements, with us persistently recharacterized iterations of (A) How to manage our economic resources while also (B) Having a high quality of life.
____________________

Meanwhile, I look at the relation between those long-term, fixed, 3% mortgages, and my mouth does still kind of water. But then I turn away from the spreadsheets and get back to things more-directly worthwhile:

Lionel Messi today led Argentina to a win over Mexico, and he may finally take home the World Cup into his retirement, despite that Argentina lost its first match to Saudi Arabia. The French side looked great against the Danes. Meanwhile, Germany lost one of its three round-robin matches. And:

The U.S. (suffering from a sophomoric error by one member of the Cup’s youngest side) held Wales to a 1-1 draw (that previously mentioned error took away the 1-0 win). Now with two draws under our belts (count ’em: 2 points), all we have left to do is beat Iran on Tuesday, the 29th, and we should advance to the next round.
____________________

I’m sorry: what were those interest and bond rates again? Something about paying off mortgages or diversifying between foreign growth equities in a downward inflationary spiral of tax-free bank accounts in the Caymans? I got distracted. Maybe get back to me in about a month.

Regards,
(($; -)}™
Gozo

Casey Campbell
Casey Campbell
2 months ago

(Long, long time reader; first-time poster): Regarding not recommending extra payments on low-interest rate mortgages (pre-2022), I understand the math fully. But . . . I also understand that if someone is only 2-3 years from retirement, the advice I’ve typically heard is to make every effort to go into retirement without a mortgage (which for us would require extra payments, even at our low 2.6% rate). Would the advice still be to forego the extra mortgage payments due to higher available returns in the bond market, or to just press on with the expedited mortgage pay-down plan (even against the “math common sense”) in order to go into retirement mortgage-free? I realize this isn’t a financial advice website, but just curious as to others’ opinions. Great article!

Nate Theune
Nate Theune
2 months ago
Reply to  Casey Campbell

Perhaps take that extra payment and invest it in something earning greater than or equal to 2.6%? Then, when the time comes, you have the option to pay off your mortgage or keep the investment.

Jonathan Clements
Admin
Jonathan Clements
2 months ago
Reply to  Casey Campbell

As Adam Grossman wrote recently, “There are usually two answers to every personal-finance question: There’s what the calculator says—and then there’s how you feel about it.”

https://humbledollar.com/2022/11/the-other-answer/

In your case, there may not be much financial difference. If you’re toward the end of your mortgage, most of your monthly payment will be going toward principal, so the amount of interest you’re paying — or the amount of interest you could earn by redirecting your extra-principal payments elsewhere — may be modest.

Charlie Sweigart
Charlie Sweigart
2 months ago

I appreciate everything but #6. I cringe when folks use investing mentality/criteria on their personal home. I get it but … it brings a whole other dimension into a integral part of living.

Michael1
Michael1
2 months ago

I get your point. We never looked at our house as an investment either but as a place to live. However, it was still part of our finance picture.

So, I don’t think point 6 implies an investing mentality. A house is a big part of the personal finances of most, so the fact they’re now harder and more expensive to buy and sell is noteworthy. Ditto for number 1 – debt isn’t part of investing (hopefully) but is part of the overall picture for many.

SanLouisKid
SanLouisKid
2 months ago
Reply to  Michael1

We also decided our house would not be an “Invesment”. We’ve lived here 25 1/2 years and have tracked every penny we’ve spent on it. We’ve now spent more maintaining, remodeling, and improving it than we paid for the house when it was built. We could care less. We enjoy it like some people might enjoy other activities.

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