The dark side of low interest rates

Nobody talks about it, but for many Canadians the low interest rates are really bad.  Folks over 60, people who do not own real estate and conservative investors are devastated.

They are losing dollars day-in-day-out without doing anything wrong.  They rely on earning meaningful interest on their savings; instead they are slowly losing.

What do I mean?

Over the last few years the attention of the media was to point out how the record low interest rates make it easier for businesses to grow and create jobs and consumers like you and me to buy a home. That`s on theory.  It`s a mantra people keep repeating without looking at the big picture and the reality.

In January 2008 the Bank of Canada prime rate started dropping aggressively from 4.0% to 0.25% in April 2009; now it is sitting at 1.0%.  During that time unemployment rose and stays higher than what it was 5-years ago.

During the same period of time housing prices kept increasing, while government regulations related to mortgages kept becoming more and more restrictive.  For many potential home buyers these two negative forces easily eliminate the advantage of the low mortgage rate.

Lines of credits have become a cheap source of money. They, however, benefit only home owners. If you are not buying real estate and don’t own one, the low rates don’t help you at all. On the contrary – they hinder your ability to grow your savings.

With the crazy roller coaster of the stock market, conservative investors abandoned stocks and mutual funds and moved their money, whatever is left, to simple saving accounts or GICs. These people are suffering big time. Consider this – a portfolio of $100,000 invested 50% in the US stock market (S&P500) and 50% in the Canadian (TSE300)in the beginning of 2000 would lose $18,000 by the end of 2008. Many Investors watching their nest eggs melting away took drastic step and moved the remaining funds into cash. It all happens when interest rates headed down and stayed there for almost 5 years now. Did they preserve the capital?

See for yourself

Bank of Canada’s site has a calculator where you can play with numbers to see the effect of inflation on your savings. For our example, the $82,000 cash in the saving account would… go even down to $80,400.

If someone is relying on supplementing a modest pension plan with earned interest, he/she is in a huge trouble. A quick review of what the big banks offer these days on saving accounts reveals a very sad picture.

TD Canada Trust offers 1-year term deposit rate of 0.7%, lock in the money for 5-years an you will earn 1.45%. Royal Bank’s high interest saving account rate is a hooping 1.2%. Scotia’s Tax Free Saving Account rate is 1.15%. All these rates are below the 20-year average inflation rate of 2.0%. Conclusion – all of these accounts will actually lose money.

GIC rates are at the lowers rate one can remember.  The once favorite saving vehicle – Canada Savings Bonds – is in the same boat. One year Savings Bond now pays 0.65%; the Premium Bond bumps that pitiful rate to exactly 1.0%.

Who should we blame for this? Mr. Prime Rate. The bad news is that these low rates are expected to stay for a long time. A really dark side of the low interest rate.

So, what do you do with your savings?

Source: http://recommendedbroker.ca/blog/2012/07/the-dark-side-of-low-interest-rates/

Written By: Vasko DeLev RecommendedBroker.ca July 12, 2012

Written By: Vasko DeLev RecommendedBroker.ca July 12, 2012

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