Interest rates have been bouncing off the bottom for years now, and today they’re lower than they’ve ever been. If you have good credit and your ducks in a row, you can now get a home mortgage, 30 year fixed, at the sub-4 percent level.
The low interest rates, overall, are a Godsend to borrowers. Consumers with good credit, financially sound corporations and government are all able to borrow money dirt-cheap, and perhaps (only time will tell) at a negative real interest rate.
Those same low interest rates, though, are a curse for savers. You can’t get the same returns you used to get on a CD, in money markets, fixed annuities, fixed-index or equity-indexed annuities, or bonds.
So what does this mean for you? Here are a few thoughts:
- Can you refinance an existing mortgage? If you’ve been paying at, say, 6 percent, on a mortgage you got a few years ago, and you can refi down at 4 percent or less, that could put a bunch of money back in your pocket every month.
- A 4 percent mortgage at a 25 percent effective tax bracket (plus, say, 5 percent in Oregon income taxes, for those of you who live in my state), is closer to 3 percent. That’s your capital hurdle rate. Can you reasonably get 3 percent on your money? Careful: It’s not as easy as it used to be!
- Are you paying down a home mortgage early? Are you paying on a 15 year mortgage when you can refi for a 30 year? With mortgage rates this low, it doesn’t make a lot of mathematical sense to pay down a mortgage faster than you have to. Yes, I realize that it just feels great to have a paid off mortgage, and there are emotional factors that come into play. But if you’re paying an after-tax 3 percent on a mortgage, and you’ve got something earning faster than that on the side, you can still make the decision to pay off your mortgage – and do it even sooner!
- Meanwhile, you still have your money. Not the bank. If you pay down a mortgage early, and then lose your job before you pay it off completely, you may need some of that money. But who knows how easy it will be for you to get a loan against your house, then? Better to keep that money on the side, where it can A.) grow faster, after tax, than the after-tax interest rate on your home mortgage, and B.) where you can control it.
- If you own a fixed-index annuity, and you’ve had it for a while, take a close look at the contract. Some issuers have lowered cap rates on it, so that where you used to be able to make up to 8 percent when stocks went up (and the contract guaranteed 2 percent in flat or down markets), now some contracts only give you an upside of 4 or 5 percent. Well, if that’s your maximum upside, there may be some more productive things you can do with that annuity. But be careful of surrender charges, taxes and penalties – the ‘dark side’ of annuities!
There are still some great ideas in the annuity world. But contracts vary so widely, and can be so hit-or-miss, that I would encourage anyone considering buying an annuity to sit down with a disinterested fee-only planner <ahem> and go through the contract to make sure it’s suitable for you, and not just for the agent’s wallet!
If you own bonds, suggest selling some of your longer-duration and/or longer-maturity bond holdings. Stick to the short end of the yield curve. Say, 5 years and less, if that far, for your bond allocation. Bond prices don’t have a lot of room to rise. And when bond prices fall, it’s going to be the longer duration issues that fall the most. And long-maturity zero coupon bonds and bond funds will eventually get clobbered!
The exception is if you have a large expense you are certain will happen at some point in the future. Zero coupons can be very good for saving for a known event at a distant point in time, if all you want is a guaranteed lump sum in five, ten or 15 years, and you don’t care what happens to prices in the meantime. (But interest rates are low, so even zeros are modest these days!).
- For life insurance and annuities, lean towards higher-rated insurers, with substantial cash reserves. These tend to be the giant mutual companies and steady dividend payers with AA ratings from Standard & Poor’s or the equivalent. (Nobody has AAA anymore, since U.S. Treasury debt got downgraded last summer, and these comprise a big part of the general fund for most insurers).
Strength matters. Remember – when these companies take your premiums and buy bonds for their general fund, they are still on the hook to honor promises and commitments they made years – even decades ago, when interest rates were much, much higher.
- This is going to be a terrific strain on the weaker insurers. If low interest rates persist, and we have one or two other serious problems, like a big avian flu outbreak that causes a big mortality spike, some of them may go insolvent. There are safeguards in place, but they’re limited and vary by state. Most insurers will weather the storm, but my preference is for the more conservative firms with huge surplus reserves. They may charge premiums that are a bit higher. But insurance is only as good as the claims-paying ability of the insurer.
A final note: Think ahead. Interest rates are low because people are scared of Europe and emerging markets now. There may be bargains there, and opportunities for the most risk-tolerant among us. But that’s small ball in the grand scheme of things. There’s an even bigger game afoot: World bankers everywhere are flooding the markets with liquidity. Cheap money. World bankers are more afraid of a deflationary cycle and collapse than they are of inflation. But if they keep up the cheap money too fast and too long, the end result, historically, is nearly always a kick-up in inflation. Take steps to inflation-proof your portfolio. More on that in a future article.