The Cost of Being Wrong About Interest Rates
Advisors make seven predictably irrational mistakes when it comes to bonds, depleting their clients’ wealth and standard of living.
1. Predicting interest rates. One person recently told me, “I don’t want bonds. I’m guaranteed to lose as interest rates continue to rise.” While it’s true that the Federal Reserve has announced that it will begin increasing the Fed funds rate, remember that is the shortest of the short-term rates – in fact it’s an overnight rate.
Roughly a decade ago in 2011, the then chief economist from Wells Fargo told me “interest rates will definitely rise.” I shared with him a study on the dismal track record of economists’ interest rate predictions showing similar results to this study by the New York Times. In fact, the 10-year Treasury Bond interest rate plunged that year from 3.30% to 1.89%. When rates continued to decrease through 2020, forecasts from economists showed similarly dismal results with predictions of increasing rates. Though rates did tick up in 2021 and this year, we don’t know if this will continue.
Why is it so hard to predict intermediate and long-term interest rates? The Federal Reserve conducts regular auctions for Treasury Bonds and Bills. If the buyers believed in the forecasts of those economists, they would bid a lower amount to get that higher return. Thus rates already would have increased.
I tell clients the best estimate of future intermediate and longer-term interest rates is today’s rates. I too have overestimated interest rates, but at least I’ve known for some time I can’t predict rates.