Interest rates never seem to be able to get it right – they’re too high, they’re too low, they’re too stagnant, they’re too volatile…what’s a rate supposed to do? Chances are the interest rates are going to continue to do what they always do, and that’s adjust to the local and international markets and economic events. Therefore, all you can do is know the right thing to do with your money in any given interest rate mood.
Interest Rates Are Low
Currently interest rates are still very low in many economies around the world, because those economies are still working hard to recover. A weak economy means people are less inclined to borrow money and many people are being careful with their spending. Interest rates are therefore dropped in an attempt to make loans more affordable and make people feel as though they have more breathing room, and that they can pick up their spending and stimulate the economy.
When interest rates are lower and loans are cheaper, the federal banks hope that people and businesses will borrow money and spend that money with other businesses who in turn grow and prosper and want to borrow money to expand too. Although this is the plan when official interest rates are adjusted, it doesn’t always go to plan because many people are already so swamped with debt, that a drop in interest rates gives them breathing room to pay more on their credit cards, and they’re not in a position to get any new loans.
So, with interest rates low lending is affordable, but it also means that many investments aren’t offering a high yield either. While you may be happy to see your home loan interest rate drop, you will also notice that the rate dropped on your savings account too. Therefore, look at some of the following options to help you decide what to do with your cash when interest rates are low.
Money Market Account
A money market account is basically a savings account but many banks will offer a higher interest rate on their money market accounts than their standard savings accounts. Plus, the larger your balance the higher the interest rate you can earn, even in low interest markets. The benefit of investing in a savings account when interest rates are low, is the fact that inflation is also very low, in some cases experts are even predicting deflation.
Typically with investments in savings accounts, especially over the longer term, any gains you make in interest can be cancelled out by the rise in inflation. For example, what costs you $100 now, may cost $110 in a year’s time, and you may only be earning 7% p.a. on your savings so you’ve actually gone backwards. However, in the case of deflation or low inflation that $100 item may still cost $100 or perhaps $102 so you have a better chance of your interest getting ahead of inflation costs.
Investing in the Stock Market
The stock market in many countries has been quite unstable in previous years, in America for example, when the credit rating of the US Government was downgraded in August 2011 the stock market suffered from this uncertainty. Regardless of the shocks and the ups and downs the overall mood is caution and recovery which is reflected in low interest rates but this can work to your advantage when it comes to investing in stocks.
For example, when interest rates are low, borrowing is very affordable, so you can easily take out a margin loan to gather some capital to make investments in good quality stocks, such as those which will pay you dividends do you don’t have to wait to sell them to reap the rewards of your investment. If you already have investments in stocks and you are worried about what the low interest rates mean for you, however, it is important to remember that stocks are a long term investment and there will always be market volatility – you should have assessed your risks going in, and reconciled yourself to an investment with a certain level of uncertainty.
Therefore, if you are already in the market your stocks will likely ride out the storm, and if you are thinking of making an investment, stop hesitating and make a commitment to a long term investment while investment loans are cheap.
You don’t have to take advantage of low interest rates by borrowing to invest, instead you can enjoy the lower interest charges on your loans. Simply continue to make your minimum repayments on your debts, and the money you are saving by paying less interest can be put towards other investments. For example you can take your cash and invest in stocks, or you can use it as a deposit to apply for a loan and invest in real estate. Real estate is another investment which may see some ups and down, but over the long term will increase in value, and with low loan interest rates it is an affordable investment now too.
Pay off Debt
Another alternative is to invest in yourself by paying down some of your debts. Reducing your debts increases your net worth, because it lessens the gap between what you own and what you owe, giving you more financial stability – which is after all the goal of any investment.
You can really benefit if you have a variable rate mortgage because your interest rate will have dropped in line with the official interest rate, but if you can keep repaying the higher amount you will be paying more towards the principal loan amount. This reduces the term of your loan and in turn the amount of interest you pay over the life of the loan.
Don’t Forget the Rules of Investment
Just because interest rates are low and there are new opportunities available to you, it doesn’t mean you should forget the basics of investing. To help you make the right investments and truly take advantage of the low interest rate situation, remember:
- Keep your investment goals in mind. It is important to remain flexible when investment opportunities arise, but you shouldn’t jump on an investment just because it is convenient if it doesn’t fit with your overall investment plan. Therefore, look at the costs and returns of your investment options, but also make your comparisons based on what you intend to do with your investment. This means if you need your investment money in the next 12 months, then the stock market probably isn’t for you.
- The greater the risk the greater the return. In most cases stocks will always earn a better return than bonds, bonds will have a higher yield than a certificate of deposit, and a certificate of deposit will return more interest than a savings account. Therefore, always make sure you are balancing the potential for investment returns with a level of risk you are comfortable with.
- Remember what long term means. While the long term average return on stocks is around 10% you have to be realistic about what long term really means. Stock market investments are measured in decades and an average is just that – one year you may see a return of 30% and the next year your stocks may drop 50%.
Interest is a bonus. Interest rates won’t be low forever, and when they start to rise again you can reassess your investment options again. Therefore, remember that if you are worried about the uncertainty of the economy, or just trying to avoid your own personal financial crisis, then the priority for your investment should be security. Any interest you earn should be looked on as a bonus, as long as your original investment is returned to you in full.