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Thread: The dark side of low interest rates

  1. #1
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    Default The dark side of low interest rates

    The dark side of low interest rates

    Aug 9, 2020

    Savers face dilemma of raiding their nest eggs or taking risks on stock market

    Jeff Sommer


    The extraordinarily low interest rates in place today are a boon when you're buying a house, refinancing a mortgage, leasing a car or paying off student debt. If you qualify for a loan, low rates can help you spend less and get more.

    But there is a dark side to falling interest rates. While they are helpful for qualified borrowers - and have contributed to tremendous returns for people who have held bonds for many years - they are terrible for savers.

    Live on less, dip deeply into savings or take on more risk in the stock market: Those are the nasty choices that many people will probably be facing. The dilemma is most pressing for those planning for retirement or already in it.

    "People who have done everything right, and managed to put away some money, didn't expect this, but they're in a tough spot," said Mr William Bernstein, an investment adviser and author.

    "A lot of them will have to consume less in their golden years, unless this turns around." The fundamental problem is that with interest rates as low as they have ever been, people with modest nest eggs can't get much safe income.

    Interest on new US government bonds, which paid more than 6 per cent 20 years ago, has dropped to laughably low levels - between 0.7 per cent and 1.3 per cent annually.

    That means that if you stash your US$1 million (S$1.38 million) nest egg in long-term bonds, you could count on an income stream of only less than US$13,000 a year.

    The situation for savers isn't likely to improve soon. Interest rates are so low largely because the economy is so weak. That economic frailty has damaged other important sources of investor income as well.

    Dividends are shrinking. S&P 500 dividends are expected to be slashed by 25 per cent to more than 30 per cent in the current downturn. That implies investors could collectively lose between US$100 billion and US$150 billion in dividend cuts in this recession, on top of losses from stock price declines.

    Low interest rates have also reduced the payout from commercially available annuities, another important source of investor income. The simplest of them, known as single premium immediate annuities, are essentially bonds wrapped in insurance.

    With these basic annuities, an insurance company will provide you with income, for as long as you live, in exchange for a sum of cash.

    But because of low interest rates, the payout on commercial annuities has fallen by more than 50 per cent over the last 30 years.

    In New York, for example, a 65-year-old man would get only US$494 a month, or US$5,928 a year, in return for a US$100,000 payment, according to ImmediateAnnuities.com, an independent site that tracks these rates.

    You might think interest rates are already so low that they must start rising, so the best strategy is to wait before making decisions about bonds, stocks, annuities or other assets. That's logical, but you may have to wait a long time.

    Consider that the futures markets have been predicting the US Federal Reserve will take short-term rates even lower, in fact, below zero. Rates below zero are known as negative interest rates; you would have to pay someone interest for the privilege of lending them money.

    That has not happened in the United States but it is already the case for many bonds in Germany and Japan, and it is a sign of severe economic distress.

    Even if interest rates don't turn negative, they are likely to remain low for some time, miring many investors in a quandary.

    For one thing, bonds are likely to be less attractive than they have been. Bonds have produced outsize returns over the past two decades - with many categories beating the stock market - precisely because interest rates fell.

    The reason is that bond prices and interest rates move in opposite directions. Mutual fund investors have benefited because the total return on bonds is a combination of interest (also known as "yield") and the shift in the price of the bonds.

    If rates turn negative, that would mean immediate profits for those who already own bonds and bond funds, but purchasers of those securities would lose income, not collect it.

    Eventually, rates can be expected to rise, but buying bonds or bond funds before that happens would imply losses down the road.

    With the appeal of bonds dimmed, some people will be tempted to shift money into stocks. That was one of the unstated goals of the Fed when it cut rates in the last financial crisis, and the central bank's intervention since March 23 has bolstered stocks again.

    But stock prices, by many measures, are not cheap, and buying in a recession is risky. For people whose main concern is preserving their nest egg, adding stock exposure may be too dangerous.

    It is a different matter for those with the luxury of long horizons. Taking on greater stock risk may make sense for them.

    Finding a comfortable allocation of stocks and bonds and sticking with it is classic advice and most likely to work in the future, if you have plenty of time.

    But for those who cannot afford that luxury, a world of low interest rates means problems galore.

    NYTIMES

  2. #2
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    Default Re: The dark side of low interest rates

    The fundamental problem is that with interest rates as low as they have ever been, people with modest nest eggs can't get much safe income.

    There are still safe income, you just need time to plan because of the Cooling measures.

    The Best Time to buy Property is Yesterday.
    If you lose Money it because you sell on a wrong Day.

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    You don't Buy others will Buy.
    You don't Sell, others will Sell.

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