Surviving a Low Interest Environment
Preparing For The Coming Surge In Interest Rates, or
How To Position Your Cash Until Higher Payouts Become Available
As anyone who has tried to
- invest in a bank CD (certificate of deposit)
- secure interest from a money market fund, or
- purchase treasury bonds
Borrowing has been made cheap in recent years by the economic powers that be, to stimulate the economy in general, to stimulate home sales, and to support industries such as banking and automobiles.
So far, so good. The American economy does appear to be recovering – in many ways, more strongly than most anticipated. Although unemployment remains high, though declining, corporate profits have been soaring. Consumer demand for services, goods, food and raw materials has been expanding – not just in the United States. Demand has been expanding pretty much across the globe as emerging nations in the Far East, South America and Asia develop their industries and increase their own consumption.
Increasing consumption has its benefits but also has its price. Greater consumption of food, water, oil and other fuels, minerals, and living space results in higher prices, and in inflationary pressures. Inflation is rapidly becoming a world-wide problem. Just check the prices on your corner grocery shelf to see its local manifestations!
High rates of inflation increase the future value of present assets, but reduce the value of money i.e.
If an automobile that can be purchased today for $20,000 will cost $21,000 a year from now, you will need $21,000 next year to purchase what you can purchase today for $20,000. The value of $20,000 set aside today for that future purchase will have declined by 5 percent.
Unless you take certain steps.What happens to various investments with inflation?
Certain items such as gold, housing, raw materials, furniture and food are likely to rise in price during periods of inflation as general prices rise. Money held today will, conversely, lose value because it can buy less in the future unless we see to an increase in its amount, and its buying power, over time by prudent and wise investment.
Investments in stocks can serve the purpose, but can be speculative.
Investments in bonds and other income investments are, however, more predictable, if not as exciting, and may be more prudent for many.
Investors as lenders
When we purchase a certificate of deposit (CD) from a bank, we are actually lending the bank a certain amount of money for a certain amount of time, receiving, in return, a certain amount of interest income -- in recent years rather small amounts, for relatively short term loans. When we purchase a US government or a corporate issue bond, we are actually lending money to the US Government or to a corporation, securing interest income over the years until the bond payment falls due to be repaid in full. The amount of interest we receive depends upon the credit worthiness of the issuer and the length of the loan, the longer the loan, the higher the interest payout.
The lending environment, and what to do now
We anticipate that investors, a few months down the road, will be able to secure higher rates of interest than they can secure at this time. In the meantime, we suggest that investors, with capital on hand, invest in certain mutual funds that invest in short term debt instruments which are relatively safe, and pay more than money market funds.You will want to remain alert to increases in interest payments available to longer term bond holders. Eventually, you will want to invest in intermediate term (7 – 10 year) bonds for higher rates of return.
Two safe havens for short term income investments
There are two short term income mutual funds that have had excellent records of consistent performance and price stability that I can recommend for consideration. These may be purchased via brokerage houses or directly via the funds.
- SIT US Government Securities: (www.SITfunds.com)
This no-load income fund invests mainly in US Government backed short term bonds issued by government backed agencies such as FNMA and GNMA. Investors received returns of 4.9% during 2010. Average bond holding is rated “A.” The fund has been profitable without exception since 1991.There are no sales or purchase commissions.
- FPA New Income: (www.FPAfunds.com) This no-load income fund invests in a blend of US Government backed and/or issued short term debt instruments as well as in corporate and municipal debt. The average debt rating is “A,” investment quality. FPA provided investors with a return of 3.18% during 2010, not exciting, but well surpassing bank CD rates. This fund has also been consistently profitable since 1991.
The Ultimate Plan:
You would want to invest in the above income funds for the time being – though they can certainly be held long term, if you prefer – until longer term bond interest payouts justify longer term investment. As a quick projection, you might begin to invest in 10-year US Treasury bonds if and when their interest payouts exceed 5% per year. Should interest rates fail to rise to this projected level, you will still be enjoying returns from the two recommended bond funds, with a high degree (but not guaranteed) level of safety.
Looking forward to a prosperous future…
Gerald Appel and Marvin Appel
Gerald Appel and Marvin Appel are officers of Signalert Corporation and authors of more than 15 books on investing. Please read our disclaimer.
Federal Funds Rate (rate that banks charge each other for loans) is near 0% in 2011
Bank Prime Loan Rate (rate that commercial banks charge their creditworthy borrowers) is at record low of 3.25%
CD Rates are near 0% - past 12 mos
CD Rates - lowest in 10 years
Consumer Price Index (top) compared to gold prices
SIT US Gov't Securities Fund
10 Year Track Record vs Benchmark
FPA New Income 10 Year Track Record
