Negative interest rates: what does it mean?

How current news affects financial planning

Much of the world has entered into a period of negative interest rates with little economic growth. Here in the United States Federal Reserve Chair Yellen still says that interest rates will rise (and she knows better than anyone) but remain at historically low levels this year. Some doubt this two-way direction is possible for government bonds in a worldwide economy. There is an increased risk that we will soon enter another recession. It is all a bit confusing. This post is meant to simply explain what this means to U.S. investors and borrowers.

Over the past week the prices of 10 year treasury bonds rose to more than their face value in many countries. For illustration, it might cost you $10,100 to buy a bond that matures in 10 years at a flat amount of $10,000. The $100 extra you pay is so that the government holds, guarantees and safeguards your money for 10 years. Think of it as a bank fee. It shows as a negative interest rate on the bond investment.

Today”s Wall Street Journal confirms that the recent market action is not a fluke. “Bank of Japan will cut its policy rate in March or sooner, to negative 0.5% from the current minus 0.1%”. In a sense, they are paying big banks to borrow money in hopes of stimulating the economy.

What this means to U.S. borrowers is unknown but unlikely to be a big deal. Credit is likely to remain tight and rates are unlikely to go up by much.

What this means to U.S. investors is that it is likely to remain difficult to earn an attractive rate of return on investment without taking increased risks. Investment management will be more important and new types of diversification over a wider range of investment options is likely to become more popular. We are likely to hear more of the term “non-traditional investments”. It also means that you should probably toss out your earlier financial plan and take a fresh look.

What this means to me as an accountant advising individuals and small businesses is:

1. Conservative low return vehicles like cash value life insurance look more attractive for a wide range of uses.
2. No longer will retirement planning simply be about choosing from among a list of available mutual funds and projecting a 6-8% long-term rate of return.
3. An increased level of “hands on” coaching about cash flow, tax planning, debt management, risk management, health care planning, asset ownership and estate planning will actually play a larger roles in improving our overall financial success than focusing on return on investment assets.