Expansionary monetary policy seeks to spur economic activity through lower interest rates. As the Federal Reserve lowers rates, the costs of borrowing for business and consumers decreases, providing the incentive for borrowing. These funds can then be used for investment in capital by businesses and for the purchase of goods and services by consumers.
While lower interest rates may have been a boon to borrowers, they have made it more difficult for savers because interest rates have remained low. With real interest rates approaching zero, savers are finding it increasingly challenging to earn a worthwhile return on their funds.
This is especially problematic for those nearing or in retirement because they may have counted on interest income as part of their investment portfolio. In this low interest-rate environment, savers and investors should consider the following six basic financial strategies:
1. Plan
Before deciding where to save or invest your funds, you must understand your financial goal(s), time horizon, and risk tolerance. Defining these will help you select options that are most appropriate for your circumstances.
A mismatch among these three factors will affect the ability to meet your goals. For example, if your time horizon is short and your goal is such that you need substantial growth, but your risk tolerance is low, it is unlikely that you’ll be able to find a well-diversified asset that will provide the return you need in time to meet your need.
Another mismatch occurs when you have a very long horizon, and can therefore accept relatively more risk, but select an investment that is very low risk and has a correspondingly low return. The lesson is that all three— goal, horizon, and risk, must align.
2. Diversify
How you allocate your assets is the most important factor in determining the return from your investments, which will affect the likelihood of reaching your financial goals.
In a low interest rate environment, this may mean looking beyond simple savings accounts and certificates of deposit. You will likely need to blend these into a larger, diversified portfolio of different types of assets such as bonds, stocks, and more. And, diversification is possible even within an asset class. For example, stocks are available for different company sizes (i.e. market caps), different sectors, and even different countries.
On the fixed income side, bonds may be issued by national governments, local governments and municipalities, private companies, and more. One way to tap into diversified investment opportunities for the personal investor is through mutual funds. Well-diversified, lowcost mutual funds from reputable companies can serve as the building blocks of a personal investor’s portfolio. Not only can you gain exposure to stocks and bonds through mutual funds, they can also provide investment opportunities in other areas such as metals, commodities, and real estate.
3. Layer fixed income investments.
If you do opt for investments that pay a fixed rate, one way to position yourself for when rates improve is to “layer” the investments so that they reach their term in successive time periods. For example, one might purchase certificates of deposit (CDs) that mature in 1 year, 2 years, 3 years, and so on.
Each year in succession, one of these will pay out and you can reinvest the proceeds. If rates start increasing, your portfolio will be postured to take advantage of higher rates as each CD comes due. And, you will also have the flexibility to invest in a better alternative if one presents itself.
4. Consider other ways to make your money grow.
There are several ways to make your money grow beyond stocks and bonds. Assets such as real estate, metals, or commodities are just a few examples that can be integrated into a well-diversified portfolio.
Another often-overlooked example is a permanent life insurance policy. The cash value of a whole life policy can grow at a crediting rate that may be greater than other investment options with similar risks. While you should read all of the terms and conditions to fully understand any fees or penalties, whole life insurance can be a very sensible store of relatively higher growth savings. In additions, some polices have features such as the ability to borrow against the cash or annuitize it if you need a stream of income. And, they offer protection to those that depend on your income.
5. Use low rates to your advantage.
As mentioned, low interest rates spur economic activity because they reduce the costs of borrowing. While we advise against adding any new debt, you may be able to put low rates to work for you if you can replace existing high interest borrowing with lower interest borrowing.
Consumers should assess their debt to determine if refinancing would help them reduce overall costs and debt burdens. Evaluate your credit cards, consumer loans, and even larger items such as auto loans and mortgages. Interest rate changes of even less than a percent can make large long-term differences.
6. Consider professional advice.
In challenging financial times, even experienced investors can benefit from assistance. If you’re not sure where or how to start, seek a trusted financial advisor who can help you with your personal circumstances. Do your homework first and be sure to research any prospective advisors. Verify their credentials and obtain references. Don’t be afraid to ask hard questions and learn about their fees, commissions, investment philosophy, track record, and experience.
There is a great deal of information on-line about how to interview a financial adviser. Review it and put together a list of questions that suits your needs. In addition, consider reputable organizations that focus on serving military and veterans and provide services unavailable through other companies.
