MARK BLACKWELL: Managing debt in a low-rate environment
by Ross Reily
Published: July 7,2014
Investors understand the concept of “Tactical Asset Allocation” — the practice of shifting investments from asset classes or sectors that seem to be overpriced to those that are expected to provide greater returns in the upcoming weeks or months.
When bonds have outpaced stocks, for example, the investor may sell some of the bonds at a profit to provide capital to invest in stocks, with the expectation that it is equities’ turn to take the lead. Similar reallocations may be made between international and domestic stocks or small cap and large company stocks. It is through this practice that many portfolio managers and financial advisors attempt to demonstrate value to their customers who have invested in their actively managed portfolios rather than static portfolios, which may simply mirror the composition of major indices, thus providing no greater return than the actual markets.
In times of historically low interest rates, like those we are currently experiencing, it makes sense to take a similar view of the borrowing practices of an individual or a business, assuming new debt or shifting existing debt between various alternatives to create the most beneficial credit solution. In its simplest form, many homeowners have taken advantage of the lower rates to refinance their mortgages, potentially saving hundreds of dollars every month and freeing up capital that can be redirected to reducing other debt, increasing savings and investment allocations, or shortening the mortgage’s duration by applying more of each payment to principal.
Credit management goes far beyond mortgage refinancing, though. Individuals and businesses have been quite active in designing credit solutions that are expected to provide interest cost savings that can be redeployed to debt reduction, additional investment, or sources of new revenue. A few examples of recently structured credit solutions include:
A widow with two children assumes a loan against her investment portfolio to build a new, downsized home for her family. In doing so, she covers the cost of the construction before a permanent mortgage can be attained and does not disrupt her long-term investment portfolio for a short-term liquidity need.
A franchisee takes on new, low interest debt against current operations and an investment portfolio to expand into a new territory.
An entrepreneur restructures a large and complex credit portfolio at half the interest rate of the current debt. The cost savings will allow him to renovate his facilities in the first year and pay down his debt more quickly in the following years.
A couple identifies a gap in their estate plan. They need an insurance policy to provide additional liquidity to the estate and they borrow money at low rates to pay the annual insurance premium. Upon their deaths, the insurance policy is projected to pay off the loan and still provide the estate needed liquidity.
Some of these solutions are quite complex, while others are fairly simple. Some involve a few thousand dollars, while others involve several million. Each, however, is designed maximize the financial benefit to the borrower. In higher interest rate environments, the customer may have decided to sell other investments, spend cash, or entirely forego the opportunity, rather than assuming or restructuring the debt. In a low interest rate environment, though, tactical use of debt may be the best solution. Call it “Tactical Credit Allocation,” because it seeks to accomplish a similar result as Tactical Asset Allocation – taking advantage of potentially short-lived aberrations in the financial markets to create the most beneficial result for the individual or business. And whether we are talking about a few months or a few years, these low interest rates aren’t expected to last.
» Mark Blackwell is the Mississippi Area Executive for Regions Private Wealth Management. He can be reached at email@example.com
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