How to find Hidden Treasures in a low interest rate world

He can’t even run his own life; I’ll be damned if he’ll run mine.

Jonathan Edwards, Sunshine Go Away Today (1970)

I hate it when I sense someone is trying to manipulate me.  I bet you do too. But when it’s the government using their powers to get me to change, I get more annoyed than usual. That’s probably how Jonathan Edwards felt when he penned the above lyrics at the height of the Vietnam war.

But the topic today is closer to home. Why am I earning only 0.10% on my money market fund when last year I earned fifteen times as much?  And what should I do about it? 

The answer to the first question is really easy. It’s the policies of the Federal Reserve. They’ve been dealt a tough hand with the economy collapsing and they are doing what central bankers do in a crisis…they lower rates quickly.

The answer to the second question is more nuanced and this blog post is written to help you find some hidden treasure to replace the lost income.

The Fed has a clear strategy. It’s called “financial repression” as they have taken away the interest income on our savings. Borrowers, on the other hand, are the winners, refinancing at record rates to lock in the low rates.

The investing goal of the Fed strategy is also working extremely well!  As savers look at the loss of interest income, the Fed hopes we will say something like this: “I could leave my money in the money market fund and make nothing, or I could put it in the stock market and make two percent on dividends alone.” And looking at the remarkable stock market rebound since April, we’d have to say they have been successful in convincing a lot of people into taking more risk.  

For the stewardship-oriented investors who reads this blog, what are some considerations about investing in this brave new world? Here are a few thoughts you probably don’t get in the mainstream financial press.

Opportunities in 2020

Examine your old insurance policies to see if there is a high interest rate floor and if you can contribute new money.  In my banking career I oversaw programs that sold fixed annuities. We sold a lot of them so I know there are many of them laying in safe deposit boxes gathering dust. You may have purchased one of these instruments because they were very safe and offered better rates than bank CD’s.  I checked and I still own two of them.  One has a 4% interest rate floor and the other a 3% floor. Both allow new contributions and still earn these high rates.  If you have any of these types of investments that you haven’t looked at for awhile, maybe it’s time to take a look at the fine print to see if you have a high guaranteed interest rate and if you are allowed new contributions.

Along those same lines, many of us have whole life insurance policies someone sold us years ago. These policies may contain a rider that allows additional contributions called Paid Up Additions. I just made my annual contribution and took advantage of this opportunity to transfer money out of a money market account and into a policy earning a much higher rate than the bank. Furthermore, the insurance policy earnings are not taxed.

Another type of insurance product that has sold well over the years is called a variable annuity. Financial planners sometimes recommend them for clients that have maxed out their retirement contributions, but still want to put away some tax deferred money. These products are complex and costly, but like fixed annuities and whole life, they may have grandfathered provisions in them that allow additional contributions at payout rates that are much higher than those now available. It’s at least worth a call to your agent if you own one to understand your options.

You snooze, you lose! You should not put money in a money market account and forget about it. Banks pay widely different interest rates on deposits. For example, many money market funds and banks are paying less than one-tenth of one percent in interest. If you want to earn ten times or more better than that, visit bankrate.com. As I was writing this post I checked and they list over a dozen FDIC insured banks paying 1% or more.

Refinance or pay down debt. Mortgage rates are at an all-time low. Banks and mortgage companies are very busy right now locking in customers with the lowest rates of our lifetime. Refinance costs average around $5,000 in many markets, but you should call a mortgage lender to get a firm estimate.  If you get that information, the calculation is simple. Divide your total closing costs by the monthly savings you can achieve by refinancing.  This will give you the number of months to breakeven. If you plan on staying in your house beyond the breakeven period, you will want to consider a refinance. If so, this is definitely a way to take advantage of the Federal Reserve’s zero rate policy. Additionally, just paying down loans with money sitting in a low yielding money market account is an automatic win for some. This is especially true for those that cannot deduct interest on taxes.

Consider developing an additional stream of income.  It’s no surprise why retirees return to the workplace. Many find the added structure, community and purpose found in a part time job are incentives enough to reenter the workforce.  But in a zero-interest world, many retirees are going to find the interest they thought they would have to live off of is not going to be there.

The economics of a part time income in a zero-interest rate world are compelling. Consider how much principle you would need to generate interest income equal to a $24,000 part time income.  Ten-year maturity US Treasury bonds currently yield about one-half of one percent. To earn $24,000 of interest on these bonds we would need $4,800,000.

Consider diversified, low cost index funds to address your need for long run growth. Ok, I started this post by saying I don’t like to be manipulated into making stock market decisions. But I’m also not willing to let that annoyance stand in the way of changing if it makes sense. Stock market strategist have a saying, “Don’t fight the Fed.” It’s a wise saying. If we are going into a long period of zero interest rates (which the Fed has announced), then how can we respond to take advantage of the new environment?

Risk tolerance is a fancy finance word that really means how much are you willing to lose in your portfolio if the market tanks before you panic and sell out. We all know the market will fluctuate and that is the cost long term investors have to pay in order to get the long-term positive results. The amount of risk tolerance is a very personal choice that you, as an investor, have to grapple with.

I am comfortable that by using low cost, globally diversified, index funds my family has the best chance in the long run to maintain our buying power. Just 2% inflation will erode almost half of our purchasing power in 20 years.  I would prefer to have a plan that partially addresses that risk by putting some more money in the stock market that I won’t need for a number of years, even though I might see losses in the short run.  Therefore, I have been adding to my stock portfolio this year, but it’s one that doesn’t go beyond my comfort level if we have a major stock market meltdown.

I’ve gone a little long today and its clearly time to hit the send button. However, I’d love to hear from you about changes you’re making in response to the new environment!

Joe Kesler

Founder, Smart Money with Purpose