What if Lower for Longer Becomes Lower Forever?
My neighbor retired this year and he is anxious. In the middle of an historic pandemic he worries about the timing.
One of the first things he decided was to downsize from his 4,800 square foot home. With kids out on their own, it was too large for just him and his wife.
Over the last 6 months, he prepared the house to list. Before he could put a sign on the lawn, he got an offer and sold the house!
But that’s not all!
The house he wanted to buy was expected to list for $1 Million dollars. When it hit the market, it listed at $1.25 Million. They were stunned.
Anecdotally it sure seems like inflation has returned in a big way, at least in the housing market. The government’s inflation numbers tell us a different story.
Therein lies the problem with historically-low interest rates. We have a situation whereby core inflation hasn’t budged, but prices of various assets like housing and stocks are going up, up, up.
For some time now, some in the financial industry have referred to historically-low interest rates as being “lower for longer.” In the wake of the housing collapse more than a decade ago, interest rates did remain at low historic levels.
In the wake of the pandemic, we’ve moved to a new lower level, and the talk has turned to this being a state of “lower forever.” Japan’s use of lower rates has persisted since the early 1990’s, could we be in for a similar result?
I’m not counting on it, but it’ll all depend on the Federal Reserve. The recent policy shift by the Fed provides hope that lower rates are not here to stay.
But I believe managing risk is a huge part of success in portfolio management, thus it makes sense to ask what if low rates are here to stay?
Those most impacted will be investors seeking income from their portfolio. The temptation will be to chase yield and increase their risk exposure to earn the income they desire.
But maybe there’s an alternative…
Certain concepts should be universally applied when managing assets. One of those concepts is diversification*. Consider maintaining a mix of investments, and avoid becoming too concentrated in a single type of investment.
Another concept relates to time and your money. You need to assess your investments in light of your own needs. How much will you need and when?
Avoid investing in securities that are misaligned with how you will need your money. Short- to intermediate-cash needs should always be funded from investments like short- to intermediate-term fixed-income securities.
*Diversification does not assure or guarantee better performance and cannot eliminate the risk of investment loss.
Investments, whether it be stocks or property, is typically considered long-term investments. Only commit the money you have that can tolerate the swings in the value of equity to these types of investments. Don’t let a strong market convince you the risks are not there!
Which brings us to the last investment concept that I recommend. Always think in terms of the total return you generate from your portfolio. Don’t get too focused on just one element driving your portfolio’s returns. At the end of the day, it’s how your entire portfolio performs that is important.
If you get too fixated on yield (aka income), current low interest rates will tempt you to move money, otherwise prudently invested in fixed income, to riskier equity-like investments. This will probably feel like the right thing to do so long as rates remain low.
The problem will come when interest rates start to move higher and the value of equities comes under pressure. That will be the moment you experience the effect of having overcommitted your portfolio to equities.
If you take a total return approach, you will continue to invest in fixed income. The goal is protecting money you need from volatile equity prices and if structured properly, may protect you from rising interest rates.
When thinking about total return, recognize that in a low interest rate environment, the investment market will favor growth. We’ve already seen that while rates are low, stocks and growth assets do quite well.
So if you stick with our advice and interest rates stay low, you should see appreciation from the equities you own help offset the lower income you are earning on your fixed income. Your total return should be fine.
More important, when rates rise, hopefully you are properly allocated in your portfolio and should not have to scramble to sell equities to protect money that cannot be invested long-term.
We are strong advocates of aligning the structure of your investments with your specific circumstances. That is, we look to understand how you will need the money you have saved and propose investment structures that align your investments with your needs.
If you would like to talk to us about your portfolio, please feel free to give me a call.