What To Do About Low Interest Rates

When the Fed recently announced that they weren’t increasing the rates they charge banks to borrow, some investors got angry. News commentators were lamenting the poor situation that savers were stuck in and how little they earn on their nest egg. While I understood what they were saying, I vehemently disagreed with their position. I’m not talking about the economic pros and cons of interest rate changes. I’m talking about personal finance.

Let’s say you have $10,000 saved up and you deposit it in the bank at .5%. After a year, you’ll earn $50. Dud.

Now, let’s say the rates shot up to……2%! Now you invest your $10,000 and take home $200 after a year. Double Dud. Even if you could earn 7%, you only take home $700 for the year.

It’s not bad of course, but it’s not going to change your life. But here’s what will keep your life stuck in the financial mud; waiting for rates to go up. That’s because short-term interest rates usually stay right around the inflation rate.

Sadly, most people don’t know this – especially young people. According to a new poll by TD Ameritrade, a whopping 76% of Americans between the ages of 15 to 24 don’t know zip about investing. Almost half of them believe that putting money in a savings account is the smartest way to save for retirement.

But as I said above, cash is probably the worst long-term investment there is. According to Morningstar Inc., stocks averaged 10.12% from 1926 to 2014. Bonds 5.67% over that period and cash brought up the rear with 3.46%. Oh…and by the way, the long-term inflation rate was 3.1%. So cash did a little better than inflation but not much. Fail.

Worried About The Crash

Since 2000, investors, especially young investors, have witnessed their families suffer through the tech stock implosion (2000 thru 2002) and the financial crisis (2008) watching their hard-earned savings melt away at the same time.

But let’s look at the facts. The investor who avoided those calamities may have kept their money in a money market fund. If so, they saw $10,000 climb to $13,472 more or less. This is what the average money market fund returned over that period.

But over that same time, an index fund that mirrored the S&P 500 grew to more than $17,000 – despite those harrowing downturns. In other words, the S&P 500 index fund returned just about twice what the money market fund did during one of the worst 15-year periods ever.

Of course this is no guarantee of future results and you can’t invest directly in the S&P 500. Still, for young people, these numbers point to a crucial point; think long-term.

So What You Should Do Now

Don’t sweat low interest rates. Rejoice instead. This is the universe telling you to do something different with your long-term money. Of course, if you need your money in a couple years or less, stick it in the bank and don’t worry about the interest rate. You will barely earn a thing but you’ll have safety and liquidity – exactly what you need for short-term money.

Dust off your financial plan. Match your investing with your ultimate goals. Stop trying to predict the future. Even if you use a dynamic approach to investing long-term, you’ll still have to deal with investment losses and disappointments. You’ll have to deal with that friend. If nothing else, the last 15 years taught us that.

Interest rates are in the basement. Nobody knows how long they’ll stay low but it could be for a long time. When rates do climb, they probably won’t be much higher than inflation – if that.

Combat low rates now – and in the future – by revisiting your plan and sticking to it.

What are you doing about low interest rates?