Have you been hearing rumblings of negative interest rates? If you’ve been reading what’s being said in financial media circles you may have heard prognosticators discussing the specter of negative interest rates. You may be asking, “What’s exactly is a negative interest rate? Who would ever invest like that?”
To understand what negative interest rates are, we first need to do a quick review of how governments fund their debt. When a government takes on debt to fund operations, they create bonds…like a U.S. Treasury bond…and sell these to investors to take in money. If you buy bonds, the government agrees to pay you, the investor, a rate of interest to compensate you for investing in their debt. Simply put: YOU become a lender to the government.
Now, imagine if you will that you lend your hard-earned retirement dollars to someone and instead of them paying you a rate of return for your loan, you have to pay them for the “privilege” of doing so. Or, suppose you’re asked to invest and then you’re told immediately how much money you’ll lose for doing so. These examples demonstrate what a negative interest rate is…an investment that implicitly has a negative return the moment you enter the transaction. Think of it like paying someone a storage fee to park your cash and receiving nothing from it in return. Negative rates are a real concern in the global bond space right now.
Balderdash, you may say! No one would ever do that!
Well, do it they have! Ignoring this situation or worse, denying its reality, could be detrimental to your retirement investment plan.
In August of this year, the German government sold 30-year bonds at negative rates paying no coupon interest at all. In fact, in August, $700 billion of global debt went into negative rate territory. Most of the negative-yielding debt is in the government bond space due to its “safety” factor but there is also about $60 billion in U.S. Corporate debt in that territory as well. With 10 year U.S. Treasuries yielding about 1.7% (at the time of this writing), when you factor in inflation, the 10 year is also in negative territory. Although the U.S. is currently not quite as bad as some of its global neighbors, the risk is still there for many different reasons too lengthy to address here. Suffice to say, it is becoming more and more likely this trend will continue within the developed world.
Bottom line: given that bond prices and yields move inversely, if investors foresee low growth and low inflation ahead they are typically more likely to buy bonds that offer lower returns. They believe that the possible price increase of the bond offers returns, even though yields may be negative. Interestingly, what is seen as the biggest bond market plunge risk to those in these high price/low yield bonds is the possible recovery of global economies in regaining economic momentum and reversing course on monetary easing.
This is really important in terms of staying on top of your retirement income plan and overall investment plan and philosophy, two of the five primary retirement plan areas of focus I speak about frequently. Global economics can turn on a dime and whats a good investment today may not be a good investment tomorrow. You must be flexible in this regard.
If you’d like to get a fresh look at your retirement plan or simply get started with one let us help you discover clear direction for your retirement.