Honestly, there are way too many things happening in the world. How on earth can we read, let alone care, about all of them!
I want to focus on one topic that I think should matter to you. Whether or not you care… now that is up to you!
Here are 4 basic reasons you should care about interest rates being so low:
- Borrowing is cheap cheap cheap.
- Investing in bonds is boring boring boring.
- Savings accounts earn you essentially nothing.
- Low interest rates promote higher inflation.
1. Borrowing is Cheap
The Federal Reserve… AKA “The Fed” sets an interest rate called the Federal Funds Rate. The Federal Funds Rate is the rate at which commercial banks can borrow. This rate is currently 0.25%.
So, say your local bank needs to borrow money overnight from The Fed. The Fed will charge them 0.25% interest on the amount they requested.
What does that mean for you??
Your local bank can turn around and loan that money to you! Because they were able to borrow money so cheaply, they can loan it to you much more cheaply too! That is why national prime mortgage rates are near 3%. This leads to cheaper car loans, student loans, construction loans, business loans… cheap money for everyone!
This is also why so many people are refinancing their mortgages right now… I have a blog coming about this specific issue soon!
2. Investing in Bonds is Boring
Note: I said that investing in bonds is boring. I did NOT say that investing in bonds isn’t necessary or good for certain investors.
A bond owner is essentially loaning money out. If you have a $100,000 30-year treasury bond, that means you loaned the government $100,000. Every year, for 30 years, the government gives you a tiny little interest payment of 1.3%. Woohoo (that woohoo was sarcastic). At the end of 30 years, the government pays your full $100,000 back.
You really gained nothing at the end to show for your 30 years of patience, considering inflation ate up your paltry interest payments.
You know what was exciting? Back in the 80’s when you could get a 10% interest rate on a bond. But 1%? Super dull. Investing in the stock market during a 30-year period would be a little more interesting too!
3. Savings Accounts Earn Essentially Nothing
Remember how I said that bond rates were super low? Wait until you see the national rate on savings accounts.
It’s 0.05%. Not 5%… not 0.5%…. 0.05%!
So, congratulations, your $10,000 savings account earned you $5 this year.
Why this matters: People are desperate to earn money SOMEWHERE. They aren’t earning it in bonds, and they aren’t earning it in savings accounts. This desire for earnings can drive people to the stock market. There is a term for this: TINA (There Is No Alternative).
This is great for the stock market as it drives up prices, but it can make financial planners a little nervous. Clients who are very conservative try to go into the stock market for income, even if it’s not suitable for them. That is a risky situation. Regardless of income potential, it’s important for you to analyze with a professional whether or not your investment choices are aligned with your financial goals and risk tolerance.
4. Lower Interest Rates Promote Higher Inflation
Back to the cheap money. Consumers and businesses alike can borrow money for cheap. Why do they borrow money? So they can spend it!
Why not buy a car and house when you can borrow so inexpensively right now?
Why wouldn’t a business use this low interest opportunity to borrow money to construct a new facility, build up their inventory, or invest in research?
This extra spending leads to an increased demand for goods. As demand for a limited number of goods increases, the price of those goods increases too (aka inflation). To meet the increased demand of goods, businesses expand and hire more workers. Now, there are fewer workers available and companies must pay them more to attract them. Higher wages lead to, again, inflation.
The Fed recently said they were willing to let inflation rise for a while before they raise interest rates again. They are okay with the economy “overheating” a little. Honestly, I am okay with it too.
I hope I brought some clarity to a relatively abstract, non-“interest”ing topic (see what I did there?)! Low interest rates can mean a lot more than we realize, and it is important to understand what could be coming our way.