Dealing with a low rate environment
Many investors watch day-to-day market performance to evaluate their investment holdings. Do I buy, do I sell, hold on, or consider other options such as sitting in cash or CDs to earn a return? There are many factors to think about. Having a low rate environment is one of them. This is a critical piece of the pie and can affect all of us for a long time, especially retirees.
How does this work? The Federal Reserve, led by Ben Bernanke, along with the Federal Open Market Committee, meets eight times a year to determine the federal funds rate. The federal funds rate is influenced by the Fed in three different ways.
First, the Fed can buy Treasury securities from the market to reduce government debt. This will lower the rate.
Second, the Fed can adjust the reserve requirement that capital banks must have on their books. This may reduce the amount of loans banks offer their customers which may affect what consumers pay to borrow.
Third, the Fed sets the discount rate. The discount rate is the rate at which banks can borrow from the Federal Reserve Banks. If this is increased, it creates higher rates for consumers, which usually reduces the amount investors save. The Fed’s influence on rates affects all of us and must be considered in retirement planning.
Having a low rate environment has its pros and cons. For borrowers, it is very positive. It allows individuals and businesses to get cheap money on mortgages, credit cards, auto loans, business loans, and other related borrowing needs. As a consumer, you are able to save by paying lower interest rates and use that savings to spend more on necessities. On the institution side, companies are able to borrow from other banks and the Federal Reserve at low costs. This provides opportunities for acquisitions, mergers, and investing in their companies for future growth.
On the negative side, financial institutions that are required to meet certain deposit minimums may only yield a low return, making it more difficult to generate a profit. Banks and financial institutions earn less on their reserves. Many times, companies will increase their fees to compensate for low-interest rates, which cost consumers more.
Also, having low interest rates provides for low returns on fixed income type of investments such as CDs, money market accounts, and treasury securities. Retirees who have low debt and rely on fixed incomes are feeling the pinch more than ever. In some cases, retirees who depend on low risk returns are having to turn to equity or bond positions to offset the low rates of C’s and cash equivalents. This becomes very challenging and presents a constant balancing act for retired investors.
In today’s market, it is much more difficult to figure out the most appropriate investment for an individual, especially one that is already retired. Most retirees rely on low risk investments to generate returns that will keep up with inflation of about 3 percent. This is much more challenging to do when rates are as low as they are today. According to the Fed’s last meeting, interest rates will continue to be low (near zero) until 2013.
When rates do start to rise, investors will need to be proactive and make change to their portfolios. Learning to manage our investments according to risk tolerance and needs is a constant battle. Working with a financial professional can help guide investors through volatility and rate changes.
For more information about having a low rate environment, visit www.jacobgold.com or call (480) 998-4653.