The True Cost of Low Interest Rates
It’s fascinating to watch. This is very likely the economic trend that will define our time. And yet very few investors have any idea what’s happening and, more importantly, how it affects their wealth.
Not only are interest rates at historically low levels... in some key parts of the world, they’re negative. It’s an incredible phenomenon that many, as recently as five years ago, believed was impossible.
The trend has dramatically affected the investing world.
For example, banks across Europe are now telling their biggest clients that they’ll no longer receive interest on large deposits. In fact, JPMorgan Chase is charging as much as 1% to leave money at the bank.
They call it a “balance sheet utilization fee.” It’s unavoidable when some 30% of Europe’s sovereign bonds come with a negative interest rate. They’re merely passing on their costs to the customer.
Again, it’s an incredible twist in the traditional investing tale.
Granted, your local bank has not started charging your savings account... yet. But you are surely feeling the effects of this phenomenon.
Throughout our lifetimes, the mantra has been the same. As we age, we’re told to sell our stocks and buy bonds. By the time we kiss the working world goodbye, we’re told to own more bonds than stocks.
These days... phooey. It won’t work.
It worked great when rates were “normal.” Most folks forget that from 1988 to 2007, two-year Treasury notes paid an average of - hold your jaw - 5.23%.
This week, after nearly a decade of Fed manipulation, those same notes yield a paltry 0.55%.
Bottom line... we now live in a world without interest rates. It’s a financial vacuum.
The question is: What’s an investor to do?
First, stockpile all of that traditional financial literature - the stuff that tells you to sell your stocks and buy bonds as you age. They’re relics. Save them for the grandkids. Someday, they’ll look at it the same charmed way they look at a phone with a dial on its face... or one that can’t access the Internet.
It’s a brand-new world for investors, especially income investors. As long as central banks rule the markets, you have no choice but to abandon tradition. You have no choice but to alter your strategy.
And that’s where things get tricky.
If you’re a Member of The Oxford Club (the publisher of Investment U), you know that diversification has long been our mantra. It’s more important than ever. But now, it’s about far more than diversifying across industrial sectors or even asset classes.
No, as long as folks like Yellen and Draghi are the puppeteers, diversification must go deeper.
These days it is absolutely vital that you spread your risk across strategies. In other words, don’t plan on your long-term dividend payers to cover your retirement. It’s the go-to strategy today, but one shock to the system and those payouts could wane.
And don’t plan on a playing the corporate bond market for the next decade, either. The current trend may continue... or Yellen could raise rates and send things south.
Some Members of the Club believe the only way to get rich and stay that way is to stay out of publicly traded assets. They stick exclusively to private equity.
Again, these strategies work today. But what about tomorrow?
The point here is we’ve stepped across the river and have walked into uncharted territory - a new financial frontier. What we’re seeing around us is not on the map. We’re not supposed to see negative interest rates.
We’re not supposed to lose money when we put it in the bank.
But we do. We’re here. Central banks have created new boundaries. As with all frontiers, we can’t be paralyzed by the unknown. But we must prepare for it.
Take time today to think about the idea of strategy diversification. Look at where your returns are coming from (our Members are making a lot of money from mid caps and corporate bonds) and ask yourself what happens if that suddenly changes.
What strategy will work next?
P.S. Are you having success right now with a particular asset or strategy? Let us know in the comments here.