Stock Preacher

Interest Rate

Rising and falling interest rates offer a special risk to stock investors. Historically, rising interest rates have had an adverse effect on stock prices. I outline several reason why:

Hurting a company’s financial condition

Rising interest rates have a negative impact on companies that carry a large current debt load or that need to take on more debt because when interest rate rise, the cost of borrowing money rises, too. Ultimately, the company’s profitability and ability to grow are reduced. When a company’s profits drop, its stocks become less desirable, and it stock price falls.

Affecting a company’s customers

A company’s success comes when it sells its products or services. But what happens if increased interest rate negatively impact its customers? The financial health of its customers directly affects the company’s ability to grow sales and earnings.

For a good example of this situation, consider what happen to Cisco System in 2000. Because a hugh part of its sales went to the telecommunications industry, Cisco’s profitability depend on the health of that entire industry. The telecom industry’s financial Achilles heel, which, in turn, become a pain in the neck to Cisco. Because telecom companies bought less, Cisco profits shrank. From March 2000 to March 2001, Cisco’s stock fell by nearly 70 percent! As of September 2001, Cisco stock price continued to decline because the companies that were Cisco’s customers where hurting financially.

Impacting Investors’ decision-making considerations

When interest rates rise, investors start to rethink their investment strategies, resulting in one of two outcomes:

Investors may sell any shares in interest-sensitive stock that they hold. Interest-sensitive industries included electric utilities, real estate, and the financial sector. Although increased interest rates can hurt these sectors, the reverse is also generally true: Falling interest rates boost the same industries. Keep in mind that interest rate change affect some industries more than others.

Investors who favor increased current income are definitely attracted to investment vehicles that offer a higher rate of return. Higher interest rates can cause investors to switch from stocks to bonds or bank certificate of deposit.

Hurting stock price indirectly

High or rising interest rates can have a negative impact on any investor’s total financial picture. What happens when an investor struggles with burdensome debt, such as second mortgage, credit card debt, or margin debt? He may sell some stock in order pay off some of his high-interest debt. Selling stock to service debt is a common practice that, when taken collectively, can hurt stock prices.

Because of the effects of interest rates on Stock portfolios, both direct and indirect, sucessful investors regularly monitor interest rates in both the general economy and in their personal situations. Although stocks have proven to be a superior long-term investment, every investor should maintain a balanced portfolio that includes other investment vehicles, such as money market funds, saving bonds, and/or bank investments.

A diversified investor has some money in vehicles that do well when interest rates rise. These vehicles include money market funds, U.S. Savings bonds (EE), and other variable-rate investments whose interest rate rise when market rate rise. These types of investments add a measure of safetly from interest rate risk to your stock portfolio.

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With a cash flow statement you ask yourself three question:

What money is coming In? In your cash flow statement, jot down all sources of income. Calculate it for the month and then for the year. Include everything, including salary, wages, interest, dividends, and so on. Add them all up and get your grand total income.

What is your outgo? Write down all the things that you spend money on. List all your expenses. If possible, categories them into essential and nonessential. You can get an idea of all the expenses that you can reduce without affecting your lifestyle. But before you do that, make as complete a list as possible of what you spend your money on.

What’s left? If you income is greater than your outgo, then you have money ready and available for stock investing. No matter how small the amount seems. it definitely helps. I ‘ve seen fortunes built when people stated to diligently invest as little as $25 to $50 per week or per month. If you outgo is greater than your income, then you better sharpen your pencil. Cut down on nonessential spending and increase your income. If you budget is a little tight, hold off on your stock investing until your cash flow improves.

Tallying up your income

Using table below as a worksheet, list and calculate the money you have coming in. The first column describes the source of the money. The second column indicates the monthly amount from each repectvie source, and the last column indicates the amount projected for a full year. Include all income, such as wages, business income, dvidiends, interest income, and so on. Then project these amounts for a year and enter those amounts in the third column.

Listing your Income

This is the amount of money you have to work with. To ensure your financial health, don’t spend more than this amount. Always be aware of and carefully manage your income.

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Liablities

Liabilities are simply the bills that you’re obligated to pay. Whether it’s a credit card bill or mortgage payment, a liability is an amount of money you have to pay back eventually. If you don’t keep track of your liabilities, you may end up thinking that you have more money than you really do.

Here are the lists of some common liabilities. Use it as a model, when you list your own. You should list your liablities according to how soon you need to pay tem. Credit card balances tend to be short-term obligations, while mortgages are long-term.

The first column in the table show the type of debt. Don’t forget to include student loans and auto loans if you have any of these. Never avoid listing a liability because you are embarrassed to see how much you really owe. Be honest with yourself. Doing this helps you improve your financial health.

The second column shows the current value of your liabilities. List the most current balance to see where you stand with your creditors.

The third column reflects how much interest you are paying for carrying that debt. This information is an important reminder about how debt can be wealth zapper. Credit card debt can have an interest rate of 18 percent or more and to add insult to injury, it isn’t even tax deductible. Using a credit card to make even a small purchase cost you if you maintain a balance. Within a year, a $50 sweater at 18 percent costs $59 when you add in the potential interest you pay.

If you compare your liabilities in the table and your personal assets on the table on the last article, you may find opportunities to reduce the amount you pay for interest. Say for example, that you pay 15 percent on credit card balance of $4000 but also have a personal assets of $5000 in a bank saving account that’s earning 2 percent in interest. In that case, you may want to consider taking $4000 out of the saving account to pay off the credit card balance. Doing so saves you $520; the $4000 in the bank was earning only $80 (2% of $4000) while you were paying $600 on credit card balance (15% of $4000)

If you can’t pay off high-interest debt, at least look for ways to minimize the cost of carrying the debt. The most obvious ways include the following:

Replacing high interest cards with low interest cards, Many companies offer incentives to consumers including signing up for cards with favorable rates that can used to pay off high-interest cards.

Replacing unsecured debt with secured debt. Credit card and personal loan are unsecured; therefore they have higher interest rates because this type of debt is considered riskier for the creditor. Sources of secured debt provide you with a means to replace your high-invest debt with lower interest debt. You get lower interest rates with secured debt because it’s less risky for the creditor.

The year 2004 was the eighth consecutive year that personal bankruptcies surpassed the million mark in United Sates. Corporate bankruptcies were also at record levels. Make a diligent effort to control and reduce your debt, or the debt can become too burdensome. If you don’t, you may have to sell your stocks just to stay liquid. Remember, Murphy’s Law states that you will sell your stock at the worst possible moment! Don’t’ go there.

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