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Subzero Rates Freeze Growth and Hold Back Your Portfolio

By | 2016, Money Moxie, Newsletter | No Comments

Crazy things are happening in the world! There is a chronic shortage of demand for goods in global economies. For years, governments have been fighting back—fighting back by dropping interest rates. Recently, rates overseas have fallen to subzero levels.

Negative rates—where lenders pay the borrowers—seemed unimaginable and foolish a few years ago. Now, they are beginning to feel like the new normal. How can individuals and countries flourish in such an environment? They can’t!

What is it like to live in a subzero-rate world?

1. The subzero world is so crazy that global interest rates are at their lowest level in 500 years of recorded history.1

2. The subzero world is so crazy that if you want the German government to borrow your money you have to pay! Hold that bond for ten years until it matures and the government promises to pay you back less than it borrowed.

3. The subzero world is so crazy that many homeowners in Denmark are no longer paying interest to banks for their mortgages. The banks are paying interest to them!

Hans Peter Christensen, a recipient of a check from his mortgage company in Denmark, said this after receiving his first payment: “My parents said I should frame it, to prove to coming generations that this ever happened.”2

The biggest borrowers in the world include the United States, United Kingdom, Germany, and Japan. The figure below shows how low these rates have become.

rates

Negative Rates Matter to Americans.
Low rates overseas make positive rates in the United States more attractive for investors, which pushes U.S. rates down as well. This makes it less expensive for us to take out a mortgage or a car loan. It creates opportunities for businesses to borrow and grow. On the surface, these low rates seem like a benefit.

Low Rates May Have Helped. Now They Hurt.
During the recession of 2008-2009, there was an economic emergency that required extraordinary effort to infuse calm and confidence.

The emergency is over. The economy should come off life support. The reluctance to move forward is now harming the very confidence it was meant to create.

Artificially low rates are also destroying natural incentives to borrow and lend.

Consumers and businesses do better when banks are healthy, but banks are not healthy. There is little profit to be made and a low incentive to offer loans when interest rates are so low. Why take the risk when the potential reward is so low?

Subzero and near-zero rates also encourage transactions that would not take place in a rational world. For example, many corporations now borrow just to pay dividends. Of the 500 largest companies in the country, 44 have paid more in dividends in the last year than their respective net income.3 This financial engineering helps investors now, but does nothing to strengthen a company or its employees.

End the Pessimism.
Despite all the positives in the economy, consumer confidence is low. Investor sentiment is terrible. Most Americans believe we still have not recovered from a recession that officially ended over six years ago.

Look around. Americans are in a good financial place. Most people who want to work have a job. Unemployment is at just 4.9 percent. In Salt Lake City, where SFS is located, that rate is just 3.6 percent.4

then-and-now

A Day of Reckoning Will Come.
The next financial scare could come after fantastic economic growth, leading to inflation and central banks would have to rapidly raise rates—shocking the economy. Or the storm could blow in from the opposite direction: economic slowdown.

If the Fed and other central banks don’t normalize rates now then there will be fewer options in the future to help keep the world economies going in a real emergency.

It’s Time to Begin Moving Back to Normal.
Central banks around the world should stop experimenting. The United States is strong enough to handle a more normal business environment. The Fed can do that by slowly bringing U.S. interest rates up.

The U.S. economy is not perfect, but it is good enough to handle borrowing one quarter of one percent higher. It could even help by sending a signal of confidence to the world—confident workers, businesses, and consumers.

Higher rates may cause the U.S. dollar to strengthen, and that could hurt American businesses that export. However, the United States has the best economy in the world and we are growing faster than any other developed country. Keeping our dollar artificially low may not be a good idea.

We can allow the dollar to rise a little as we bump up interest rates from their near-zero levels. This message of confidence may help increase demand worldwide—giving investors something to cheer about as well.

 

1. Bill Gross, “Negative Interest Rates a Supernova,” Janus Funds, June 2, 2016.
2. Charles Duxbury and David Gauthier-Villars, “Negative Rates Around the World,” Wall Street Journal, April 14, 2016.
3. Mike Bird, Vipal Mongaand, Aaron Kuriloff, “Dividends Eat Up Bigger Slice of Company Profits,” Wall Street Journal, August 18, 2016.
4. Federal Reserve Bank of St Louis.

Research by SFS. One cannot invest directly in an index. Diversification does not guarantee positive results. Past performance does not guarantee future results. The opinions and forecasts expressed are those of the author and may not actually come to pass. This information is subject to change at any time, based upon changing conditions. This is not a recommendation to purchase any type of investment.

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BREXIT Surprise: What Investors Hate More Than Uncertainty

By | 2016, Money Moxie, Newsletter | No Comments

“If you want to see the sunshine you have to weather the storm.” This advice from Frank Lane describes well the fortitude needed to invest successfully, especially in 2016.

This year began with two extremes: one of the worst starts ever for the stock market followed by a sharp reversal into positive territory. The second quarter gave us something completely different: calm—that is, until Britain’s exit vote from the European Union (BREXIT).

United Kingdom

Surprise!
Most experts did not expect the “exit side” to get 51 percent of the vote on June 23rd. This shocking outcome sent global stocks into a tailspin. After all, there is one thing investors hate more than uncertainty—surprise!

Then a reversal: Six days before the vote and six days after, the S&P 500 index was roughly equal.

We can’t dismiss this historical event completely. The BREXIT vote is profound, not just for its economic impact, but because it clearly demonstrates the extent of anger in Britain and the world with slow growth. The change is contrary to the way the world has been moving since WWII—a time of globalization that has been relatively peaceful and prosperous for the world.

Now, Pandora’s box has been opened and the discontented individuals around the globe may feel emboldened by the BREXIT outcome. The British will now try to stop Scotland and Northern Ireland from leaving the country, as well as businesses in the UK.

Global Trade
If the movement against global trade continues, there may be adverse effects. These could include lower growth and higher inflation.

U.S. Dollar
Uncertainty sends investors to “safer” areas like the U.S. dollar. As the dollar strengthens, imported goods become more affordable and “Made in the U.S.A.” goods become more expensive. A strong U.S. dollar can also hurt U.S. companies because their exports are more expensive to consumers outside this country. Of course, as investors, we are owners in many of these companies.

The strong dollar was a problem in 2014 and 2015 for corporate earnings and the stock market. How big of a problem it is in the future depends on how high it goes.

Interest Rates
Low interest rates may be around for a while longer. The Federal Reserve wants to raise rates back to “normal.” However, it can’t risk destabilizing the markets and it wants to stay away from influencing the election.

Consumers
Short-term benefits to consumers will come in the form of lower interest rates and a strong dollar. Rates could be even more attractive on mortgages, auto loans, and other forms of debt.

A strong dollar should also help make international travel and international goods a little less expensive. Even the rise in oil prices should slow down, which will help keep gasoline prices down for consumers.

Volatility in stocks may increase as investors adjust to the new realities. I would consider any significant drop as an opportunity.

BREXIT is unlikely to have a major impact on U.S. consumers’ jobs, wages, debt, or spending. U.S. consumers are strong and their spending drives 70 percent of U.S. economic growth!

This surprising storm has passed and the sunshine has appeared again. While uncertainty may drive the market over short periods of time, economic growth will drive it in the coming years.

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Investing in 2016 The Fed and Election Years

By | 2016, Money Moxie, Viewpoint | No Comments

January MarketPoint_Page_1

(1) Historically, when rates rise they rise sharply, but “this time will be different.” This phrase raises a red flag. However, I see no need for the Federal Reserve to increase rates quickly. Our economy is growing slowly and inflation is near zero.

Oil and food are unlikely to keep dropping in 2016 like they did in 2015. So, inflation may rise. (Without food and energy inflation is currently 2 percent.)

The Fed stated it may raise rates 4 times this year, but I am not convinced it will do that many.

Normally, rate hikes would be negative for bonds, but U.S. bonds are still paying attractive dividends compared to others overseas.

(2) Election years are not recession years. The economy will expand as the recovery in the United States enters its 8th year. The next slowdown is coming and no one knows when. However, I don’t see convincing data for its arrival in 2016.

Election years usually start positive, slow down in the summer, and then rally in autumn–similar to most years. However, the rally in the fall does not typically begin after election day like many investors believe. It usually begins before the uncertainty is over–catching many off guard that are waiting. The average for a presidential election year is 9 percent.

(3) United States grows and the dollar slows. Global diversification should help investors in 2016, but the United States will continue to be a financial leader. Global returns will hinge on the U.S. dollar.

Since July 2014, our dollar has risen in value against every major currency around the globe! It gained 20 percent versus the euro and 54 percent versus the Russian ruble!

Why the big move? In all the world, our economy is one of the best and we are the only ones raising rates. Both of these make our dollar more attractive to global investors.

With so many countries lowering rates to stimulate growth, it is possible their economies will strengthen and the dollar’s rise will slow. Overall, this would be good news. It would likely help those that have diversified globally.

market graph

Does 2015 offer any clues as to what 2016 will bring? In 2015, the S&P 500 finished within 1 percent of where it started. This has only happened in 4 previous years (1947, 1948, 1978, 2011). What happened following those respective years? In 3 out of 4, the market was up more than 10 percent. The outlier was 1947. It was followed by another low return year and then came the double digit. Of course, there are no guarantees.

History does firmly support the value of diversification and investing over the long run.

 

*Research by SFS. Data from Federal Reserve Bank of St. Louis. Investing involves risk, including potential loss of principal. The S&P 500, S&P 600, and Dow Jones Global are indexes considered to represent major areas of stock markets. One cannot invest directly in an index. Diversification does not guarantee positive results. Past performance does not guarantee future results. The opinions and forecasts expressed are those of the author and may not actually come to pass. This information is subject to change at any time, based upon changing conditions. This is not a recommendation to purchase any type of investment.

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Rising Rates Will Impact: Your Income Your Spending Your Investments

By | 2015, Money Moxie, Newsletter | No Comments

Federal Reserve (Fed) members are making plans to raise interest rates and it is going to affect your wallet! Individuals do not borrow from the Fed, so you may be wondering how it could impact you. The Fed’s rate increase will start economic ripples that are going to hit your income, your spending, and your investments.

The Fed
The Fed was established by Congress and signed into law by President Woodrow Wilson on December 23, 1913. It has two objectives: seek maximum employment and maintain stable prices. (It is a highly sophisticated organization with over 300 Ph.D. economists.)

In simpler terms, the Fed is less like a surgical tool and more like a hammer. A hammer is blunt and its impact can be powerful. It doesn’t perform a lot of functions, but it is extremely useful for the right problems.

The Fed has power to perform a limited number of actions. It can strike hard and fast because it does not need congressional approval and its officials are not elected. The Fed is not focused on individuals as its actions have worldwide implications.

Why the Fed Changes Rates
The purpose of changing rates is to influence decisions that will help control unemployment and inflation.

In a slow economy: If spending decreases then companies become less profitable and may choose to layoff workers, which will further decrease spending and profitability. The Fed will try to reverse the cycle by lowering rates. When the Fed rate changes, other rates follow. This may encourage spending as it makes it cheaper to borrow for education, cars, homes, etc.

In a healthy economy: When the economy is thriving and the job market is good there is a lot of pressure on companies to raise wages. Confident consumers will spend more even if prices rise a little. When prices increase beyond a “healthy rate” of around two percent, the Fed gets worried. It may raise rates to decrease borrowing and spending.

Rates will Rise
Rates have been low since 2008 when the Fed brought short-term rates down near zero percent. Those who were able to borrow benefited from low interest rates. Right now the Fed is not worried about price inflation, but it does want to get rates back up to “normal.”

bag of money

Your Spending
The result will be higher rates when you take out a mortgage or get a loan for a new car. Anything with a variable rate, like some credit cards, will probably see an increase. Debt is going to get more expensive. Paying debt off and living within your means will be important.

Your Income
The labor market is improving. Many companies have announced plans to raise wages for workers, but the expected improvement has not yet hit. It’s coming!

briefcase

Wage growth was just around 2 percent in the last year and the Fed believes the country is headed towards 3.5 percent. This is good news for workers and it gives the Fed confidence to slowly raise rates to normal. However, if wage growth is too high the Fed will become uncomfortable and will really drop the hammer down—acting quickly, with force just to make sure prices don’t get out of control.

Your Investments
Back in 2013, Ben Bernanke, then Chairman of the Fed, suggested the Fed might end (taper) its stimulus. The stock and bond markets went crazy! The event even has a name: “The Taper Tantrum!” In the end, the Fed continued its stimulus.

The Fed is unlikely to catch investors by surprise when it finally does raise rates. Its members have been quite open about its plans and the economy is able to withstand a very gradual rise in rates.

percentage

Investors should expect more volatility, but in spite of the choppiness, the returns should still be positive. That’s what we have seen in the past.

Prepare Your Personal Economy
Make sure you are saving some income for rainy days even if it means cutting back on a little spending. Make sure the risk you are taking in your investments matches your ability and willingness to handle it. Finally, align your portfolios for the future.

Will the Fed hike rates in September? Will it be just 0.25 percent? How long will the Fed wait to make its next move and will it go too far too fast? The answers will be “data dependent,” a phrase the Fed members have been using lately. It will depend on U.S. economic growth, wage growth, and price inflation.

A gradual economic improvement will allow time to digest the news and act slowly—waiting months between each rate increase to see the impact. There are no signs of overheating for now. If that changes, the Fed is not going to sit idle. It would have to act. After all, to a hammer, everything looks like a nail.

 

*Research by SFS. Data from public sources. This is not a recommendation to purchase any type of investment. Investing involves risk, including potential loss of principal. The S&P 500 index is often considered to represent the U.S. market. One cannot invest directly in an index. Past performance does not guarantee future results. The opinions and forecasts expressed are those of the author and may not actually come to pass. This information is subject to change at any time, based on market and other conditions, and should not be construed as a recommendation of any specific security or investment plan.

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Powerful Performance

By | 2014, Money Moxie, Newsletter, Viewpoint | No Comments

Economic growth in the United States was slow last year as the federal government dropped one potential bomb after another. However, none of these exploded and U.S. stocks had their best year since 1997. With all this positive momentum would it be too much to ask for an encore?

In January we escaped a close call with the fiscal cliff. Then came sequestration. By May, Ben Bernanke had dropped another bomb: tapering. Before the end of 2013 we endured a government shutdown.

Duds

Interest rates shot up last year with fear the Federal Reserve (Fed) would slow its bond-buying program. In 2014, this action is slated to become a reality.

Each month the Fed plans to slow its purchases by $10 billion. As it does, let’s keep in mind that any purchase is extra stimulus to the economy. The Fed is still flooding the economy with money. Some may compare this to pushing on a string, but the last few years have helped validate the phrase “Don’t fight the Fed!”

As the Fed becomes less involved as a driver of economic growth we may see more ups and downs in the stock market. In all likelihood, the coming year will be more volatile than last year.
When the next drop comes, let’s keep in mind that it is perfectly normal even in a healthy market to have some hiccups. A fall of 10 percent in stock markets occurs on average about once a year. These drops can even be healthy for long-term growth.

According to the Wall Street Journal, strategists believed the economy would slowly improve and the market would rise 8.2 percent in 2013. It rose 30.
This year, the economy is expected to grow faster, but predictions for stocks are more moderate.

The driving forces of growth should be similar. Domestic energy production is still rising. The housing recovery is underway. Employment is improving. Wages are expected to rise and changes in consumer spending are trending in a positive direction.

Improving economic growth does not necessarily mean more stellar stock returns. Sometimes the two can be out of sync as investors look to the future for something to get excited about. Nevertheless, stocks and the economy are closely related and the economy is still heading in the right direction for now.

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The Federal Reserve Will Soon End its Easy Money Stimulus

By | 2013, Money Moxie, Newsletter, Viewpoint | No Comments

When Lehman Brothers collapsed in 2008, all lending essential stopped. The U.S. Federal Reserve (Fed) feared that all five investment banks in this country would cease to exist. No one fully understood the financial calamity coming, but we were beginning to feel what the worst recession in 80 years would be like.

The Fed acted to stop the financial infrastructure from imploding. It believed cushioning the blow was necessary to help all Americans. It started the Troubled Asset Relief Program (TARP). It added to that program over the years with Quantitative Easing (QE) one, two, and three.

Recent years may not have felt like easy money to us, but there is likely no organization more profitable in recent years than the Fed.

The Fed doesn’t literally print money (a responsibility of the U.S. Treasury). It doesn’t have to. Money is created electronically by the Fed and infused into the financial system through open market actions. Its effectiveness is questionable. Its impact is global. And at some time soon it may be ending.

What Is the Fed’s Impact?

Currently, the Fed is spending roughly $85 billion each month to buy treasury bonds in order to keep long term interest rates at historically low levels. The goal is to encourage risk taking. The Fed wants banks to lend, businesses to hire, and consumers to borrow.

If you have purchased a home, refinanced a loan, or bought a car with debt, then you have benefited from these unprecedented efforts of the Fed.

All this money the Fed is creating seems to be working to a small degree. The U.S. stock market* is on track for its fourth positive year in the last five. If you have invested in stocks or bonds consistently during this time, you have probably benefited from the Fed’s actions. Experts have been debating how well the Fed’s historic efforts have worked. One theory is that each time the Fed spends, it has less positive impact than the previous effort. This would explain the lackluster growth in the economy.

Why Is the Fed Still Involved?

Simply stated, the benefits still appear to outweigh the risks.

Low interest rates are meant to be enablers for businesses and consumers to increase borrowing. If the debt gets out of hand, then we will be facing similar problems to those that got us into this mess.

If spending and demand increase too much, then inflation could rise to levels considered too high for a developed economy (greater than 4 percent). At that point, the Fed will have to react to try to slow down the economy even if it means job losses.

At this point, official inflation is tame and private debt levels do not appear inflated like in 2007.

As long as the risks appear low and unemployment is above 7 percent, the Fed is likely to keep spending.

What Will Happen When the Fed Slows Stimulus?

Interest rates will rise from the unusual levels where they currently are to a more natural rate determined by investors. We experienced a taste of what this will feel like this spring and summer. Rates on the 10 year treasury almost doubled in just a few months. Investors saw an increase in volatility.

Where Is the Silver Lining?

Don’t fight the Fed is a common phrase for investors. The Fed is powerful and it is working for what it believes is best for Americans. It plans to cut stimulus only after it determines that the U.S. economy is strong. If rates rise that should bring better yields for savers.

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“The Most Powerful Force in the Universe”

By | 2013, Newsletter, Viewpoint | No Comments

Those who understand interest, receive it. Those who don’t, pay it. As investors, we believe this and we strive to go one step further. We seek to get paid interest on our interest. We call this compounding interest.

Albert Einstein called compounding interest “the most powerful force in the universe” and “the eighth wonder of the world.”

It is this mathematical force that has driven the Dow Jones Index to new highs and to over 15,000 this year.

Like everything in life there is a catch. It takes time to achieve compounding interest and it involves uncertainty.

Time

One of the first questions we ask investors is “What is your time horizon?” In other words, “When do you plan to spend this money?”

This is critical because it may take some time to realize the benefits of compounding interest. On June 30, 1993 the S&P 500 was at 450. Fast forward one year and the return was negative 1 percent. Move forward ten years and the total return was 116 percent. Twenty years later, in 2013, the total return was 256 percent!

It pays to be patient with investments. It pays to keep a long-term perspective.

Uncertainty

The stock and bond markets do not travel in straight lines.  There are days when they rise and there are days when they fall. If we don’t accept the uncertainty, then why would we expect to receive a reward.

As investors, we must accept some risk and we believe that over long periods of time, these markets will reward us.

In the last 50 years, the S&P 500 has gained 2,215 percent. Despite this fact, the market was positive only 42 percent of the months. That sounds like a frightening outcome, but the average return for all months was still a positive 0.6 percent.

The good news is that the longer the time period, the more likely an investor is to achieve growth. Positive returns occurred in 53 percent of the years, in 60 percent of 5-year periods, in 80 percent of 10-year periods, and in 100 percent of 20-year periods.

What can we expect in the future?

I believe there is still room for growth. I believe potential for improvement in technology, housing, energy, and employment could fuel this growth.

I expect that the further we look in the future, the more likely we are going to see opportunities to compound returns.

I believe the Dow Jones Index, which currently is flirting with the 15,000 level, is likely to reach 30,000. In my mind it is not a matter of if, but when.

What does all this mean? As we like to say at SFS, “Now is always the best time to invest.”

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5 Ways Rising Interest Rates Will Impact Your Life

By | 2013, Money Moxie, Newsletter | No Comments

On May 21st, the Federal Reserve Chairman, Ben Bernanke, announced that the Fed was going to start tapering their bond buying program sometime in the fall. In essence they feel the economy is doing well enough that they don’t need to keep pumping as much money into it. Ironically, the better economy is both good and bad news, depending on your perspective.

The bad news came as mortgage rates jumped about one-half a percent within a month. That left many people wondering how they will be impacted as interest rates continue to rise in the future. Here are five things you should know about how rising interest rates will impact your mortgage, savings accounts, and investments in bonds.

1. Mortgage rates are still low, but are on the rise.

The mortgage rate cruise ship has just started its engine as it prepares for a long cruise to the North. We have probably seen the lowest rates that we will see for a long time, maybe even our lifetime. This isn’t to say that everyone should abandon ship and never plan to move. Life doesn’t work out that way. It just means that if you are planning to move, and the move is in your control, then it may be better to move sooner rather than later.

Interest rates in the 4’s and even 5’s are still incredibly good by historical standards. As interest rates rise, you will either see your anticipated mortgage payment rise, or you will need to look for a slightly smaller and less expensive home. For example, the monthly payment on a 30-year mortgage of $400,000 went up by about $100.2 So, either you will find it in your budget to afford the additional $100 or you will look for a less expensive home.

2. If you are thinking of refinancing, you better do it soon.

Most people with equity in their home and great credit have already refinanced. However, if you have procrastinated, listen to the last call of “all aboard” and get on the low rate cruise ship before it leaves the harbor. If you didn’t have enough equity to qualify before, check again, because “rising (home) prices pushed 850,000 homes into the black in the first quarter.”3 If you are still underwater, you may be available to refinance through HARP. Check out the details at Harpprogram.org.

3. Lock in your rates now, if you are ready to buy.

This may help you avoid any short-term rate spikes. “Most lenders won’t charge for a 45- or 60-day rate lock.”4  Only pay for a longer rate lock if the deals are closing slowly. You should be able to ask your lender about this ahead of time. Also look for a free float down option in case the rates dip a little. Mortgage rates are still close to their all-time lows. So, lock in a rate for a long time, especially if you are looking to get a 30-year mortgage.

In this current environment, an adjustable mortgage makes sense only if you know you will move within a few years. You don’t want to get a 5-year adjustable loan and stay in the home for 30 years.

Rates going up will probably slow down the housing recovery a little, but it won’t be derailed. Rates are going up because the economy is healthier. For savers, the increase in interest rates is a mixed bag.

4. Interest in savings accounts, CD’s, and money markets will increase.

This is good news and bad news. The good news is that the abysmally low rates we have seen for the last few years will go up a little. The bad news is that you probably still won’t keep up with inflation.

One concern is that we may have inflation like we did in the ‘80s. So, if you are looking at putting your money in a CD or other investment that is locked up, avoid locking it up for a long time. For example, right now may NOT be a good time to put your money in a 5-year CD paying 1%. Inflation was already 2.1% in 2012.6

If inflation goes up higher, being locked in and earning only 1% would feel like a jail sentence. Another strategy would be to place your money in a one-year CD and roll it into a new CD every year anticipating that rates may go up each time you renew.

5. Bond investors, be cautious.

Since the market crash in 2008, many people have fled the stock market and moved into bonds in search of safety. However, bonds are not without their own risk. As inflation increases, the value of a bond may actually go down.

Many bond investors have seen this firsthand as they have watched bonds in their account stay flat or go down despite the growth in the stock market this year. This is not to say that you should get out of bonds completely. Even aggressive investors often have some bond exposure to help with the unpredictability of the future. However, in a rising interest rate environment you have to pay attention to what types of bonds may still do well and incorporate those bonds into your portfolio.

The good news is that there is a general consensus that the U.S. Economy is healthier and continuing to move in the right direction. However, this will most likely lead to higher interest rates, which can be both good and bad. Pay attention to how you will be impacted and if needed, make some moves now so the impact won’t be a tidal wave.

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