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Past Articles: Important Message about IRA Conversion Opportunities Can You Afford Long-term Care Insurance?
About SC&H Financial Advisors, Inc. Personal Financial Planning is not a one-time event—it is a critical, ongoing process that, if managed well, leads to financial freedom. At SC&H, we develop complete and flexible plans that are designed to meet your ongoing needs. They are complete, because you need a fully integrated and comprehensive financial strategy that incorporates all of the most important wealth care issues. They are flexible, because milestones in your life such as a marriage, a career change, the birth of a child, a divorce, or a death in the family will require adjustments to your overall financial plan. To learn more about these services, visit www.scandh.com/fa. |
In This Issue: Surviving the Zero Interest Rate Environment
As always, feel free to give any of us a call with questions. We are happy to help.
Regards, Greg Horning Surviving the Zero Interest Rate Environment
Take a look at your most recent bank or brokerage statement and examine the rate of interest you are being paid on your cash. If it's not zero, it's likely close to it. Many of today's investors - especially retirees - are becoming increasingly worried about the low rates of interest being offered on cash deposits, including CDs (certificates of deposit). Since late summer 2006, interest rates have been steadily declining, with the most rapid decline occurring over the past 24 months. Prior to that time it was not uncommon for banks and other financial institutions to offer interest on cash deposits of as much as five percent. Many investors are now asking such questions as:
Before providing some answers to these questions, first let's explore how interest rates are determined, as well as the role they play in our economy. The interest rate, when defined in its simplest form, is the level of compensation a lender is paid by a borrower. In today's environment this level of compensation is exceptionally narrow, which on the surface may seem like a bad thing, but in reality is not. For this discussion, we will focus primarily on the rates paid to those who lend to banks, including lending through savings accounts or CDs. When opening these types of accounts, you are lending your cash to a bank in exchange for compensation in the form of an interest payment. The rate you earn is determined by many factors, but the genesis of that rate is set by the U.S. Federal Reserve (often referred to as the Fed). The Fed members, headed by Chairman Ben Bernanke, meet eight times per year to determine the benchmark Federal Funds rate target and have two primary objectives: price stability (keeping inflation in check) and maintaining sustainable economic growth. Although the Federal Funds rate does not directly, or even immediately, impact the rate of interest you are paid by your bank, it is the primary starting point for determining market interest rates. This target rate is set by Fed policymakers based on two primary factors: their perception of growth throughout the overall economy and the extent to which they see inflation as a problem. When the economy is growing quickly, the Fed can increase its target rate in an effort to reduce the rate of growth since banks and businesses tend to borrow less when rates are higher. Conversely, when the economy is slowing, the Fed will lower rates to encourage more borrowing and growth. Furthermore, as the threat of significant inflation escalates, the Fed can boost rates in an attempt to keep the potentially ruinous increase in prices from really taking hold. As we continue to endure historically low interest rates, it can be challenging to find investments that provide any significant level of interest income. However, the types of investments that do yield more interest can pose exceptionally high risks. As the saying goes, there is no free lunch. The laws of supply and demand make it extremely difficult to find high-yielding investments without incurring higher level of risk. This is the reason banks offer their most credit-worthy customers the lowest loan rates — because the borrower's potential for default is lower than most. Conversely, when you lend your money to a bank via a savings account or CD, to a corporation in the form of a bond, or a government as a savings bond or Treasury bond, you are compensated based on their level of default risk as determined by the market and the duration (time) for which you lent the money. As the level of risk and duration increases, so does the amount you are compensated in the form of interest. Although current interest rates may not appear appealing, the situation is not really different than it was in the early 1980s when rates were at historical highs. That's because, back then, inflation rates were high. Inflation is an overall increase in the price levels of goods and services. When inflation is high, you can expect to pay more for the same item tomorrow than what you paid today. Along with high inflation comes higher interest rates: Investors want to be compensated more to make up for the erosion in the value of their money - especially when it's being lent for longer periods.As a result, the 'real' (inflation-adjusted) rate of interest tends to be the same to the investor, although in a low interest rate/low inflationary environment this is not perceived to be the case. For example, if inflation is at 8% and the average savings account is paying 9%, your 'real' rate of interest is 1%. However, if inflation is at 0.5% and the average savings account is paying 1.5%, your 'real' rate of interest is still 1%. We have been carefully scrutinizing any investment with a yield that's well above the general market yields, especially since such abnormal yields are accompanied by greater risks, or other less-than-favorable terms. For instance, many banks are offering CD rates in the 3% range. However, to get this yield you may be forced to commit to a term of as long as four or five years. By committing to such a long term, you also lose the ability to access that money for emergencies or other important family needs. Furthermore, should rates rise during that period of time, you lose the ability to invest your money at the prevailing higher rates. In today's low-interest-rate environment, it is difficult to be satisfied when your cash appears to be earning next to nothing. However, we stress that the protection of your principal should outweigh the allure of earning a few extra percentage points of yield in a higher-risk investment. With inflation still low, you should feel more comfortable knowing that while your cash is not growing as fast as it used to, neither are the prices you pay for most goods and services.
Securities offered through Triad Advisors, Inc. Member FINRA/SIPC. Advisory Services offered through SC&H Financial Advisors, Inc. SC&H Financial Advisors, Inc. and Triad Advisors Inc. are unaffiliated entities. |
