The Great Fed Taper – What You Need To Know
The future of any economy, even in the short term, is essentially unpredictable. Events like natural disasters, pandemics, and political upheaval can set financial systems spinning. Governments are cognizant of this and to the best of their ability seek to stabilize their respective economies. Here in the U.S. that responsibility is given to the Federal Reserve. Using the tools on monetary policy, the Fed tries to keep the economy on an even keel. The Fed’s next anticipated move is “tapering”. Let’s find out what’s behind this financial maneuver and how it may affect your Self Directed IRA.
Covid and the response of the Federal Reserve
Covid hit the U.S. economy hard. Workers lost jobs, entertainments venues were shuttered, and supply chain disruptions wreaked consumer havoc. Seeing the disaster looming, the Fed stepped in to try and get things back on track. It did this with two major monetary moves:
- It cut short-term interest rates to zero.
- It restarted QE – Quantitative Easing – which is the buying of Treasury and mortgage-backed securities.
QE is a secondary strategy for when normal monetary maneuvers are no longer available. It works by putting additional cash into the economy. This increases the money supply and gives banks more liquidity. In turn this causes consumer interest rates to fall (e.g. private mortgages or car loans) which encourages spending.
However, it’s not good to keep up QE without limit. Prolonged economic stimulus can lead to a variety of negative situations including inflation and increasingly high-risk investment behaviors. To curb these problems, the Fed has to walk a fine line. On one hand they have to stimulate the money supply to the point where the economy is strong enough to continue on its own. On the other hand, they can’t give too much “free money” as this can also have ruinous effects. The process of winding down QE at the appropriate time is called tapering.
Currently, the Fed has not yet started the taper. Every month $120 billion worth of bonds and securities are being purchased. However, the economy is improving and inflation and housing prices have been rising. These are strong indicators that it's time to start tapering. Consequently the Fed has let it be known that tapering is on the table and it’s just a question of when to start the process.
How to Taper Responsibly
Everybody likes the “free” money that comes with QE. Cutting it off requires a sensible approach to avoid any adverse reactions. Even just mentioning tapering can cause market movement. This was the cause of the infamous “Taper Tantrum” in 2013. When then Fed Chair Ben Bernanke told Congress that a tapering was anticipated, it led to a massive global sell-off in stocks and bonds. This time around it seems as if the Fed has been able to mitigate the situation by talking a lot about tapering without actually putting any near-term plans in place. Investors have become acclimated to the concept and are no longer being easily spooked. While there has been some market slowdown in response to hints of a taper, it’s not even close to the 2013 downturn.
The Taper and Self Directed IRAs
Most of the economic predictions concerning the taper center around stock prices and the bond market. For Self Directed IRA account holders, these assets are not of primary interest. Those who open self directed retirement accounts tend to not be heavily invested in classic market products. Such assets are easily accessed via brokerage or online trading accounts and don’t require a self directed platform. Rather, the favored assets of Self Directed IRAs are real estate, private placements, and alternatives like cryptocurrency. Although the popular press doesn’t focus on these assets, they can certainly be affected by tapering.
If you recently opened a Self Directed IRA and want to purchase a property, how should an upcoming taper affect your strategy? Although it’s impossible to predict the specific outcome of the tapering, most analysts agree that we can expect the following:
- Rising mortgage rates – A direct consequence of the Federal Reserve pulling back on QE will be an increase in mortgage rates. When the banks don’t have the same unfettered access to cash, rates will naturally rise.
- Stabilizing home prices – Currently home prices have been experiencing a boom. However, as mortgage rates go up, less people will be looking to purchase homes. This will slowly begin to turn the housing market into a buyers' market as prices stabilize. This also means that home sales overall should experience a decline.
A classic Self Directed IRA strategy is to buy a conservative multifamily property and then rent it out. Is this still a good decision with the upcoming taper? The answer seems to be yes. The U.S. is currently experiencing a housing shortage. There is a dearth of affordable housing and rents have continued to rise. This may become exacerbated with a rising mortgage rate. Even though house prices can fall, the rising rates will make it more difficult for many people to afford a mortgage. Those would-be buyers will have to turn to rentals for accommodation. The increased demand for rentals should keep their prices high.
The Self Directed IRA Process
If an investor wants to take advantage of the current situation and buy a rental property, how can they do so with a Self Directed IRA? The first step is to choose the right kind of self directed account. For a rental property, an IRA LLC or IRA Trust with checkbook control would be good options. These accounts will allow you to effortlessly take care of the numerous transactions involved with a rental property, while at the same time avoiding transaction fees.
To find out more about the different kind of Self Directed IRA accounts, speak with a Madison specialist. Tell them about what you want to do, and they can help you decide which Self Directed IRA is the best fit. You can schedule a call here.