How do low rates hurt everyday people? - October 24, 2019

How do low rates hurt everyday people?

The Fed cutting rates again, low interest rates seem to be back. These hurt the economy for several reasons – we have written about that many times. But let’s look at the low rates from the perspective of the everyday people.

Close to zero interest rates and QE programs are brought back by central banks. The Federal Reserve cut its rates not long ago, while the European Union has a -0.5% rate, just like many other developed countries. We have often said that this is bad for the economy, but it’s also bad for the everyday people.

A problem for the people

In market environments with close to zero interest rates people tend to spend less. This has historical backgrounds. We’re used to good, or at least decent returns for our bank accounts. In the past, people kept their money in the bank and had clear earnings. Not huge amounts, mind you, but for a long while it was obvious to keep money in the bank.

With these super-low rates, this period seems to be over for now. For elders this makes no sense. Many of them take their money out of banks and keep it in cash. We already discussed the problems with that attitude in this post. In short: cash is far from being the best possible investment.

Holding back, missing out

Another thing people do is to stop spending. When people see that their money is not growing in their bank accounts, they often get scared. This also has historical backgrounds and leads to less spending and more saving. But that isn’t always the best of ideas. First, less spending can hurt the economy on the long run and can be a self-fulfilling prophecy. Other than that, being careful is good when we’re thinking about investing. Being scared isn’t.

The reason is simple, and we talked about it many times on this blog: the best thing to do with our wealth is to diversify it. If someone is only saving up cash, it isn’t diversified. They can feel relatively safe, but in reality, they aren’t. A currency can lose (some of) its value, but when having several stocks, bonds, and commodities there’s a smaller chance of them losing value at the same time. What’s more, in times of higher volatility  great investment opportunities can open up.

The real price of emotions

With this, we come to the question  of what’s the worst thing someone could do. Investing with serious fears. Emotions should be left out of investments. Not long ago, we wrote about the price tag of choosing emotions over discipline in investing. JP Morgan found out that “Six of the best 10 days occurred within two weeks of the 10 worst days”.

This means that if an investor got scared during those bad days, and sold their instruments, they could only reach a 6.1% profit, instead of a 9.85% return. That’s a $33 thousand “loss” in case of a $10 thousand investment in 20-years.

In short, low interest rates still hurt economies, but it can also make people hurt themselves. We can’t change how central banks work, but with clever diversification everyone can try and prepare for what’s in their best interest.
