Street$marts: Interest Rates: the good, the bad, and the complicated

Charity Willett, Fixed Income Associate

Hi, I’m Charity Willett, Fixed Income Associate at Howe & Rusling, and today I’m going to be teaching you about interest rates. So, interest rates are low: why should you care and what can you do about them? It all comes down to which side of the equation you find yourself. Interest is the amount charged by a lender to a borrower for the use of some asset, and in every transaction that involves interest rates there is just that: a lender and a borrower. Now we, as individuals, most often think of ourselves on the borrowing side, borrowing money from larger lending institutions, say banks for example. When interest rates are low, we have cheaper access to money to make large purchases. We’re living this right now, and I’m sure you’re hearing it all around you: everyone is buying new houses! In fact, home prices are soaring nearly everywhere, and while there are lots of factors at play, one of those factors is low mortgage rates. People can in part justify over-paying for a home when what they’ll pay back long-term in interest is at ultra-low levels, historically speaking.

So what about businesses and large entities as borrowers? How do they think about low interest rates? Mostly in the same way! If a business has cheap access to capital, it is more likely to invest in itself through expansion and innovation which can eventually lead to job creation or higher worker productivity or more cutting-edge technology. Smaller or newer firms can enter the market and have access to funds they normally wouldn’t have been able to afford, encouraging healthy competition.

From a borrowing perspective, whether you’re an individual or a hospital or Amazon, low interest rates have a stimulative effect… hence the Fed cutting rates when it feels the economy needs a boost—such as at the start of the COVID pandemic when the world shut down.

But, switching gears, what about on the lending side of the equation? Low rates are a very different story. We might not be conditioned to care about the bank getting a poor return on its loans, but we care a lot more when WE are the lenders… when it is our own savings and investments that we’re hoping to grow with interest. At this point, it has been well over a decade since interest rates were even remotely “high”, historically speaking. This means there’s an entire generation of people who’ve never even experienced high rates. But many do remember the 1980s when the Fed allowed the fed funds rate to approach 20%! It was not uncommon for a CD savings account to earn, say, 15%… beating out the stock market’s annual returns in many cases. Again, many of us can’t even fathom this today—to be compensated so generously for taking on essentially zero risk. In today’s low interest rate world, cheap borrowing means that lenders, or investors, don’t get paid as much to lend, so they go on the hunt for more yield. This yield hunt can lead investors to loan money to non-credit worthy borrowers, and can then artificially inflate the value of a particular asset and create a bubble that can cause a pretty big mess if and when it’s popped.

So, as the lender (or investor) in a low rate environment, what do we recommend?  We recommend keeping your expectations for yield as low as the current rates and to always remember your objective and your risk tolerance.  Because more yield can’t be gotten without taking more risk.  If you can afford to take more risk, bonds or dividend-oriented stocks might be appropriate.  However, if your objective for the part of your assets that is in cash remains capital preservation and liquidity, or if you have an upcoming spending need, then we recommend keeping that part of your portfolio in cash and accepting the low interest rates while trying to keep in mind that the low rates will not last forever. 

Thanks for tuning in, and we’ll see you next time!

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