The issue of low interest rates
As we come out of the holiday period and life resumes, one of the many questions we are now pondering is where to invest during this period of low interest rates. The answer, of course, greatly depends on whether you’re a borrower or an investor.
The impact of low interest rates on borrowers
Obviously, the conditions are much better if you’re a borrower in these times of low interest. This is especially true for consumers, governments, and businesses with strong credit ratings. As the government works its way through the pandemic, low interest rates make taking on additional debt for stimulus purposes and servicing this debt much more manageable. For us as consumers, interest payments on mortgages decrease and we are in a position to either pay down more principle on our loans or have access to more funds for discretionary spending. Consumers may also choose to build their investments through an investment property or other assets. Businesses too have options in these periods of lower interest rates including the ability to access cheaper capital that could see them fund innovation or make upgrades to plant, machinery, and equipment.
Impact of low interest rates on investors
Depending on what type of investments you hold, prolonged periods of low interest rates generally have weaker results. Cash accounts and term deposits have low rates and bonds have only marginally better returns.
With that being said, share markets and private equity firms can fare well in these periods as they deliver greater returns for their clients than cash holdings would achieve. Businesses with greater access to cheaper finance are in a better position to grow while remaining profitable and some continue to pay dividends during these times. Over the past year we’ve even seen companies that are not yet profitable or that are not paying dividends experience share price growth. While many investors focus on dividend payments as a measure of the success of their shareholding, the capital growth of an equity is also an important consideration. It is possible for investors to create a revenue stream from capital growth by selling down some of their shareholdings as total value grows. This too can be a method for creating more free cash during a period of lower interest rates.
As always, our advice is to have a plan established so that you are prepared prior to any economic changes. This plan needs to consider more than your short term cashflow goals, it must also consider where you are in your life stage and your desired view of the future. In short; what’s right for you. Our view is that this is the best way to significantly reduce the stress of ‘I’m getting nothing at the bank, what should I do with it?”
Date published 29/01/2021
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