The Price of Money: What Interest Rates Actually Mean for Your Balance Sheet

So often we discuss interest rates through the lens of an investment market variable. It's easy to lose sight of what interest rates actually are: the price of money. And that price quietly influences almost every major decision a family or business makes with their balance sheet.

There are three primary places that rates show up in real life.

1. The Cost of Carrying Debt

Probably the most obvious and tangible one.

A business with a $10,000,000 floating-rate line of credit would incur approximately $250,000 in additional annual interest expense if the underlying rate increased by 2.5 percentage points, or 250 basis points, assuming the full balance remained outstanding.

The same concept holds true for consumer debt such as:

• Adjustable-rate mortgages

• Securities-backed lines of credit

• Margin loans

• HELOCs

• Credit cards

The increased cost of carrying debt needs to be addressed through thoughtful planning. Interest rates may rise for a variety of reasons, including efforts by the Federal Reserve to address inflationary pressures. When inflation remains elevated, the Federal Reserve may raise short-term interest rates to moderate economic activity and help bring inflation under control. However, rate decisions also reflect employment conditions, financial stability considerations, and the broader economic outlook.

And while the Fed only controls the very short end of the curve, consider mortgages, which more closely track the 10-year Treasury. The Fed doesn’t directly control the 10-year yield. Instead, the bond market looks at factors like government spending, economic growth, and inflation and effectively says, “If these trends continue, I need to be paid more to lend money for longer.” Long-term yields rise, and the cost of long-term borrowing—including mortgages—rises with them.

2. The Hurdle Rate for Using Capital

Suppose someone has $1,000,000 available and is considering:

• Paying down a loan

• Buying a building

• Investing in the market

• Holding onto cash

• Expanding a business

At 0% interest rates, holding cash was extremely expensive in terms of the opportunity cost. Borrowing at a marginal rate of 2-3% was also very cheap. You may remember the days of TINA (there-is-no-alternative) as a reason to buy, invest, consume, and grow.

At materially higher rates, that calculus changes. Paying down a 6% floating rate loan creates a very different economic benefit than paying off a 2.75% mortgage. Investing in the stock market may require a different evaluation when Treasury securities and other relatively conservative investments offer materially higher yields than they did during the near-zero-rate environment.

Higher rates don't simply make borrowing more expensive. They raise the standard that every use of capital has to clear.

3. The Value of Optionality

For years, advisors and investors told clients not to hold excess cash because it earned essentially nothing. Today, liquidity itself can generate meaningful income.

That changes decisions around:

• How large a cash reserve to maintain

• Whether to borrow against a portfolio versus sell investments

• How quickly to deploy proceeds from a business sale

• Whether to finance large purchases

• The level of working capital a business should maintain

There is the behavioral benefit of less pressure to make an investment simply because cash feels unproductive. While the optionality has always existed, it's a much more nuanced decision now.

Rather than predicting the directionality of rates, wealthy families and businesses should answer the following questions:

• What debt do we have and which rates are floating versus fixed?

• What happens to our annual cash flow if rates move 1%?

• Where are we borrowing?

• Where are we holding excess liquidity?

• What upcoming expenses do we have?

• Which debts could reasonably be retired?

These are clearly not questions with universal answers. And while we love to listen to the folks predicting where rates are heading next, they're paid a lot of money to have an opinion that they get wrong all the time. Bring it back to your balance sheet and control what you can control.

This communication is provided for general informational and educational purposes only and should not be construed as personalized investment, legal, tax, or accounting advice or as a recommendation to buy or sell any security or adopt any investment strategy. 

Any opinions expressed are current as of the date of this communication and are subject to change without notice. Readers should consult their investment, tax, and legal professionals before making any investment decision. Links are provided for informational purposes. Chagrin Valley Legacy Advisors does not guarantee the accuracy or completeness of unaffiliated third-party content. Advisory services are offered through Chagrin Valley Legacy Advisors, an investment adviser registered with the State of Ohio and other applicable jurisdictions. Registration does not imply a particular level of skill, training, or endorsement by any securities regulator.