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The Up and Downsides of Low Interest Rates

Seth Jentner10/02/2013

Near the end of 2011, the Federal Reserve Board, acting in the midst of a U.S. debt downgrade by Standard & Poor’s, delivered a first-ever pledge to keep interest rates at current low levels for the next two years.

The pledge was historic and, for the Fed, even radical. Usually the Fed indicates where it currently wants to see short-term rates and little else. The Fed doesn’t usually like to telegraph its moves and would rather let the market speculate on its future actions.

This time, faced with a sharp slowdown in the world economy and the U.S. debt downgrade, the Fed said economic conditions “warranted exceptionally low levels for the federal funds rate at least through mid-2013.”

With rates still low, for the time being, this commitment is somewhat of a gift for consumers planning their future. Over the past two years, for instance, those who had variable-rate home-equity loans and who previously worried that interest rates were on the way up could rest easier as their rates probably would remain stable for the next two years. This gave them time to either pay down their loans or refinance at a low fixed-interest rate.

Anyone who planned on buying a home also had more assurance that they could get a mortgage at historically low rates. The national average interest rate on a conventional 30-year fixed mortgage is hovering between 4% and 4.5%.

Homeowners who had mortgages with interest rates above 6% and with 15 or more years of payments remaining could benefit by refinancing their loans.

However, those who kept money in the bank or in a money-market fund didn’t necessarily like the Fed’s pledge. Interest rates on short-term deposits were very low and were likely to remain that way for another two years. At the time, the national average one-year certificate of deposit rate was less than 0.9%. At that rate, it would take more than 77 years to double the size of a CD!

Those seeking a higher rate had more assurance that short-term, high-quality bonds, which were yielding more than bank deposits, would retain their values over the next few years. That made them more attractive to investors who want extra yield without much more risk.

Stock market investors could also benefit from the low rates. If the stock market calms and it appears the economy is growing again, it is possible that investors stuck in low-yield alternatives will start putting money to work again in stocks, driving up prices and returns for current stockholders.

Low interest rates can create both opportunities and threats for investors. Through proper planning and by implementing a broadly diversified, global portfolio of both stocks and bonds, investors can navigate their way to a successful investment experience.

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