Interest Rates: The Good, The Bad, The Ugly

Interest rates were low for a very long time. We got used to mortgage rates at 3-percent or lower and savings accounts paying next to nothing.  

Then came inflation and with it the Federal Reserve’s hiking up of interest rates. Now we were paying north of 6-percent for our houses but at least we could find 4- and 5-percent interest in savings and money market funds. 

Now we’re headed down again. 

Is that good or bad? To hear the politicians, we need to have interest rates as low as practical. Yet super-low interest rates are a big problem for those who avoid stocks. No matter how often I espouse the benefits of having a modest allocation to stocks in a retirement portfolio, many people stick with bonds, CDs, and fixed annuities in their retirement accounts. The Fed dropping rates might be good for the economy overall, but not for these folks. 

The Federal Reserve is lowering, not to punish savers (though that happens), but to help people and businesses borrow, and then spend, money. This helps other businesses and employs more people. And while I generally don’t encourage people to take on a lot of debt, one major source of debt, housing, can lend itself to positive results when handled correctly.  

When I bought my first house, the loan was at 14.5% interest. I know what you are thinking—but no, I had great credit. It’s just at that time the Federal Reserve was trying to slow down the economy, not speed it up, and making loans hard to afford was a great way to do that. These days interest rates in the low single-digits are our normal.  

While I don’t think everyone should own a house, for many it is a good long-term investment that produces many standard-of-living advantages. If you’ve decided that home ownership is right (and affordable) for you, then the Federal Reserve is trying to be your friend. 

Because of this, those who save into income investments (like the aforementioned bonds, CDs, and fixed annuities, among others) will find that what were wonderful short-term rates in the 4- to 5-percent range are heading down to 2- 3-percent. This is pretty close to historical averages.  

For you savers and retirees who liked the higher income that came from very safe investments, you’ll have to either take a bit more risk or less income. Longer-term bonds will bring higher rates in exchange for losses should interest rates shoot up again. Moving from government bonds or bank accounts into corporate bonds brings with it default risk. And while the allure of dividend-paying stocks might draw your attention, remember that they come with ever-present volatility. 

Yes, things are changing. Aren’t they always?