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Low Interest Rates: A Double Edged Sword

By LouAnn Schulfer, AWMA®, AIF®
Accredited Wealth Management AdvisorSM
Accredited Investment Fiduciary®

Years of low interest rates have been great for borrowers as their cost of capital is historically cheap.  Low rates spur the economy by encouraging spending.  Lending institutions have been busy writing and rewriting loans for years.  For savers though, low rates sting.  Investors have considered government bonds to be a safe way to generate income.  However, as rates drop, the amount of principal needed to produce an identical amount of interest has risen substantially, as you can see in this chart showing the past 25 years of rates and the dollar amounts needed to produce $20,000 in income.

Government  and corporate bonds have also been used as diversifiers in portfolios to offset the market risk of stocks.  Bonds have both the opportunity to produce income through yield as well as fluctuate in value as interest rates change.  While rates have fallen, the values of bonds has generally risen.  However, when rates rise, the values of bonds decrease.  If for example, you have the opportunity to buy two existing $100,000 bonds, one is paying 3% and the other is paying 6%, the value of the 6% bond is more because it produces more income.  Therefore, the seller of the 3% bond would have to sell to you at a discount, for less than the $100,000 face value of the bond to be a competitive seller.  Bondholders who do not plan to hold to maturity should weigh this risk when analyzing their portfolios.

While low interest rates are great for borrowers, for savers and investors, it’s the other side of a double edged sword.

LouAnn Schulfer is co-owner of Schulfer & Associates, LLC Wealth Management and can be reached at (715) 343-9600 or  Securities and advisory services offered through LPL Financial, a Registered Investment advisor.  Member FINRA/SIPC.

Content in this material is for general information only and not intended to provide specific advice or recommendations for any individual.  There is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio. Diversification does not protect against market risk. The market value of corporate bonds will fluctuate, and if the bond is sold prior to maturity, the investors yield may differ from the advertised yield. Government bonds and Treasury Bills are guaranteed by the US government as to the timely payment of principal and interest and, if held to maturity, offer a fixed rate of return and fixed principal value.