Investing Strategy When Interest Rates Are Low

Posted on October 16, 2013 at 7:02 AM PDT by

If you remember investing in the 1980s, you probably remember when certificates of deposits paid handsomely. But what is the investing strategy today, when interest rates are low and likely to stay there?

It’s madness, really. A “high yield” money market account pays less than 1% these days. No problem, you say, I’ll buy a CD. Well, that’s going to pay 2% or less right now.

Given that inflation is right at 1.5%, your money is standing still at best. Those might be safe investments, but you sure aren’t safe from inflation.

investing strategy

When you adjust a given interest rate for the effect of inflation, you get what economists call the “real” rate. It’s an accurate term, certainly. This is the number you “really” get, when all is said and done: On a money market, negative 0.6% and on a CD a positive return of just 0.5%.

But hold on, that CD requires you to hold it for five years. Will inflation still be 1.5% in five years’ time? Or will it be higher? That’s a pretty high-risk investing strategy right there. If you lock your money down at a “real” 0.5% and inflation takes off, you’re investing strategy is cooked.

Consider what these rates do to a retirement fund. To double your money in 10 years, you need about a 7% average annual return. If you get 0.5% — assuming inflation does not change — you double your money in 139 years. Feeling safe now?

What’s the answer? A lot depends on your willingness to invest in the markets. If you simply cannot bring yourself to own stocks and bonds, your choices are limited. If you can invest, there are ways to get a decent return without necessarily rolling the dice.

1. Own dividend paying stocks

Some companies don’t offer a dividend, but many do. It’s not necessarily a good idea to buy the highest-yielding stocks for their dividends alone. Many high-yielders are also high risk. But a large number of blue-chip firms in sectors such as pharma, energy, utilities and telecommunications offer yields of up to 6% or more.

2. Buy high-yield debt

So-called “junk” bonds got a bad name in the 1980s when takeovers were in vogue on Wall Street. In a sense, there’s a reason they’re called junk. If you buy debt issued by a company with a very low credit rating, you are taking on the risk that it might not survive long enough to pay back the principal. Yet owning a slice of this market through an ETF can be a good way to bump up yield as part of your overall investment portfolio.

3. Invest in foreign stocks and bonds

Foreign companies and governments are not “junk” by any stretch but they face the same credibility problem of challenged companies. As a result, they pay a higher rate of interest than you are likely to find at home. Their pain is your gain, if you keep the size of such holdings reasonable.

All investing strategy requires that you measure your ability to take a loss in a down market, but investment risk should be carefully weighed against the unseen and underappreciated risk in a time of low interest rates and, potentially, rising inflation.