Investing in a Low Interest Rate Environment
by Mitchell J. Smilowitz, CPA
Since the Great Recession in 2008, interest rates have fallen to historically low levels. For the week of August 10, 2020, the average interest rate for savings accounts in the U.S. was 0.06%; six-month CDs averaged a 0.14% rate of return.
What Drives Today’s Low Interest Rates?
The main driver of short-term interest rates is the Federal Reserve (the Fed). In an effort to spur economic growth in the wake of the COVID-19 pandemic, the Fed reduced its target for short-term interest rates to 0.00% – 0.25%. Low interest rates make it cheaper to borrow money and encourage consumer and business spending. In response to continued unemployment and low inflation, Federal Reserve Chairman Powell said he expects the Fed to keep short-term interest rates low for the foreseeable future.
Long-term U.S. Treasury rates reached historic lows in 2020. The 10-year Treasury Note now sits in a range of 0.60% – 0.80% (compared to 2.06% in 2019 and an historic average of 4.44%). The 30-year Treasury Bond currently yields about 1.45%. The decline in Gross Domestic Product (GDP) and low rate of inflation makes it unlikely that long-term rates will increase substantially in the near future.
Progress in combatting COVID-19 is likely to be the main driver of economic recovery. Failure to control the virus is likely to continue to put downward pressure on interest rates. Development and deployment of a vaccine is likely to catalyze a recovery in economic conditions and eventually support higher interest rates.
If Interest Rates Are Low, Why Are Bond Funds Doing So Well?
It’s a paradox. While interest rates are low, bond mutual funds, such as those offered by the JRB, are providing solid returns. The answer to this seeming contradiction lies in the fundamentals of bond performance.
A bond mutual fund owns many individual bonds. A bond fund holds bonds from a variety of government and/or corporate issuers. The fund acquires the bonds at different times. As a result, the bonds have different maturity dates and interest rates. Previously purchased bonds with a higher interest rate are worth more – increasing the value of the bond fund’s portfolio. Alternatively, a bond fund can sell some of the higher interest bonds it holds for more than face value – and generate a higher rate of return.
Strategies for Reducing the Impact of Low Interest Rates
- Consider investing in the JRB Stable Value Interest Fund (returning 2.25% for the 3rd quarter of 2020).
- Outside of your JRB account, you can search for higher returns on your personal savings. With savings accounts often offering less than 1% interest, you may be able to shop around for a higher return from an online bank.
The COVID-19 pandemic has created significant new challenges for investors. Bonds and stable value investments remain an important component of a diversified portfolio, but a review of your fixed income assets may be valuable. Please contact the JRB at 888-JRB-FREE (572-3733) or send us an email to discuss your portfolio.
August 2020