The Hidden Costs of Sustained Low Interest Rates
By Greg Sweeney, Chief Investment Officer, Bell State Bank & Trust
Reducing interest rates across the spectrum may be backfiring
From a retiree’s point of view, the impact of today’s low interest rates is painfully evident: there is very little interest income to provide for living expenses. The Federal Reserve has made a point of reducing interest rates across the spectrum in an effort to encourage borrowing to stimulate economic growth. It may be backfiring. Consumers are not in the frame of mind to take on more debt, while low rates have made it very difficult for people living on fixed incomes to generate any money to spend.
Hidden challenges of sustained low rates
Behind the scenes, sustained low interest rates are creating other, less visible problems. Corporate and municipality pension plans, also known as defined benefit plans, promise to pay beneficiaries a predetermined amount of money each month during retirement. Each year, these plans are evaluated to determine if the plan sponsor (corporation or municipality) has set aside enough money to meet its promises. As interest rates drop, more money must be set aside to meet obligations, even if there is no change in the money to be paid out to beneficiaries. In the case of a short-term decline in interest rates, accounting rules allow a plan sponsor to spread new cash contributions across several years. As interest rates remain low, they become more permanent, cost more money and can spiral into substantial costs in a short period of time. This will hurt corporate Market Engagement earnings and put pressure on municipalities that already have strained resources.
Insurance companies collect premiums for car, property, health and other types of coverage. They invest these premiums in bonds to earn interest income in an effort to keep insurance rates competitive and to generate income to pay claims. As the insurance companies’ ability to generate income goes down, the pressure to raise premiums goes up, and customers end up with higher premium expenses.
These are just two of the hidden challenges of sustained low rates. The pension situation is particularly concerning because of the scale of expenses that can accrue in the face of lower yields. This is one of the many features we look at when evaluating stocks for consistency, as we create a diversified portfolio across large, medium and small cap stocks, value and growth characteristics and all sectors in both domestic and foreign holdings. For long-term investors, this combination of consistency and diversification provides a more solid foundation than you can build by choosing a particular index or market that ebbs and flows in popularity.
If you’d like to talk more about your financial security , call Greg Sweeney to start the conversation.
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