Low Rates: Good for Borrowers, Bad for Savers

Since the beginning of the financial crisis, the Federal Reserve has employed several monetary policy tools in the hopes of stimulating the economy and improving employment. One policy has been a commitment to keep short term interest rates near zero for the foreseeable future. Longer term rates have followed the shorter term rates lower. The hope is that the low rates will encourage borrowing which will stimulate demand. For example, corporations could use the cheap money to finance growth strategies, consumers could fund large purchases such as houses or automobiles and local governments could finance capital projects such as upgrading infrastructure. For potential borrowers, these low rates are a tremendous benefit. A $350,000 loan for 30 years is nearly $500 cheaper per month than it was a couple of years ago.

However, the low rates aren’t welcome relief to everyone. If not already, individuals will soon begin to feel the effects of low rates in their pocketbooks:
• Penalty to savings: Prior to 2008, it was pretty easy to find a shorter term CD yielding     5%. Today, this same CD yields less than 0.50%. This is a loss of $4,500 per year of income per $100,000 invested.
• Profitability is being squeezed at financial service companies. Consumers are likely to face   rising fees from banks (remember Bank of America’s attempt to charge $5 per month to use an ATM card?). Here at PSG, we are already seeing insurance premiums being increased by life insurance companies.
• Pension funds and endowments are not hitting their needed returns. Most of these funds are assuming actuarial returns of 7% or more. With 10 year treasury bonds yielding less than 2%, these funds likely don’t have a chance of generating these types of returns. Municipalities may be forced to raise taxes to plug holes to meet the promises made to retirees. Colleges may have to raise tuition if a significant portion of their operating expenses is coming from the endowment.

As an investor, be careful of stretching for income. Any potential investment that is not guaranteed has downside risk. Countless times over the past year, we have been asked by clients how to reposition savings accounts, money market investments or proceeds from a CD that has matured. Our answer has been that if you can’t tolerate any losses, keep it safe. Give up the interest and upside to protect against capital loss. Be wary of investments that offer above average rates.

We recently had a client contact us to look into an investment that another firm was recommending. The client was elderly and did not like losses. However, she also did not want to earn near 0% which was what her savings account was paying. The proposed investment was pitched as a safe, income alternative. We looked at the investment and found that the assets would be invested in a collection of closed-end municipal bond funds. Yes, the investment did offer significant income above that of CDs and savings accounts. However, we pointed out that several of the bond funds lost over 20% in 2008! There was no guarantee the the client’s principal would be returned. In our opinion, this investment did not meet her primary goal of capital preservation.

The bottom line is to understand the opportunities that low interest rates present, but also evaluate your investment options carefully before you take unnecessary risks with money that you need to keep secure and liquid.
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As the Director of Investments for Planning Solutions Group, Jon Giordani provides clients with innovative investment planning strategies. Prior to joining Planning Solutions Group, Jon worked in the institutional market place as a Vice President of Institutional Sales for Deutsche Bank and as a research analyst for Croft-Leominster. Jon is a Chartered Financial Analyst (CFA) charter holder and holds NASD Series 7 and 63 registrations. Jon graduated from the Johns Hopkins University where he majored in Economics.