(NYTIMES) – If you’re saving money for the future, somehow, you better be prepared to lose some of it.
It is the involvement of today’s upside down world in financial markets. The combination of high inflation, strong economic growth, and very low interest rates means that “real” interest rates – what you can earn on your money after accounting for inflation – are inferior to what they have been in modern times.
This result is the result of a glut of global savings and the extraordinary efforts of the Federal Reserve to bring the United States economy back to health. And that means that the choice for a saver is difficult. You can invest in safe assets and accept a high probability of getting back less, in terms of purchasing power, than what you invested.
Or you can invest in risky assets where you have a chance to generate positive returns but also a substantial risk of losing money if market sentiment turns negative.
“For people who are risk averse, they have to get used to the worst of all possible worlds, which is seeing their little pool of capital shrink in real terms year on year,” Sonal said, chief investment officer of Franklin Templeton Fixed Income. Desai.
Inflation above interest rates is good news in certain circumstances: if you can borrow money at a fixed rate, for example, and use it to make an investment that will add something of value over time. whether it is a house, farmland or equipment for a business.
But consider the options if you’re not in that position and saving money you think you’ll need in five years – for a down payment on a house or a child’s college expenses, for example.
Cash versus investment
You can keep the money in cash, for example through a bank deposit or a money market mutual fund. Short-term interest rates are at or very close to zero, depending on where exactly the money is parked, and Fed officials plan to keep rates there for maybe a few more years. Inflation has been 4-5% over the past year, and many forecasters expect it to slowly decline.
Or, you can buy a safe treasury bill that matures in five years. The annual yield on this bond was less than 1%. This means that if annual inflation is higher than this, the purchasing power of your savings will decrease over time. The most profitable federally insured bank certificates of deposit over this period only offer a little more, a little over 1%.
The stock market and other risky assets offer potentially higher returns, with some degree of inflation protection. The profits of the companies that are the basis of stock valuations are skyrocketing, one of the reasons the major indexes have hit record highs in recent days. But with that comes the pervasive risk of a massive sell-off – tolerable for people with long-term investing but potentially problematic for those with shorter horizons.
Inflation remains well below the double-digit levels it sometimes reached in the mid-1970s to the early 1980s. But at that time, interest rates were much higher – and they moved mostly in tandem. with inflation trends, unlike in recent months when consumer prices have skyrocketed while bond yields have fallen.
This environment of extremely negative real interest rates leaves those whose job it is to analyze and recommend bond investment strategies with few good options to advise.
“It’s even difficult to make a case for fixed income at these levels,” said Rob Daly, director of fixed income at Glenmede Investment Management. “It’s the old ‘pennies in front of a steamroller business’.”
That is: someone who buys bonds with ultra-low yields receives low interest in exchange for taking the substantial risk that higher inflation or soaring rates could more than wipe out the gains (when interest rates rise, existing bonds lose value).
For these reasons, he recommends that investors allocate more of their portfolios to cash. Yes, he will pay almost no interest, and therefore the saver will lose money in inflation-adjusted terms. But that money will be ready to be invested in riskier, longer-term investments whenever conditions become more favorable.
Likewise, Mr. Rick Rieder, director of global fixed income investments at BlackRock, the huge asset manager, recommends that mid-term investors build a portfolio that combines stocks, which offer the potential to rising corporate profits, with cash, which offers security even at the cost of negative real returns.
“It’s surreal,” he said. “This is one of those times when fundamentals are completely out of touch with reality. The current real interest rate situation makes no sense compared to the reality we live in.”
The US central bank, in addition to keeping its short-term interest rate target near zero, buys US $ 120 billion (S $ 162 billion) in securities each month as part of its quantitative easing program , and only now are starting to talk about plans to reduce these purchases. . This has the effect of putting a huge buyer in the market which drives up the price of bonds, and therefore lowers rates.
Fed officials believe that the strategy of maintaining an eased monetary policy even as the economy is well under way in its recovery will help quickly restore the US labor market. The aim is also to establish credibility that his 2% inflation target is symmetrical, meaning he will not panic when prices temporarily exceed that target.
Many people involved in market strategy are far from happy with this approach and the consequences for potential investors.
“Nominal yields are low because of what the Fed is buying,” said Dr Desai of Franklin Templeton, adding that “it’s ridiculous given where we are” with growth and inflation.
At the same time, Americans have racked up trillions in additional savings during the coronavirus pandemic, money they are putting in all kinds of investments, which has pushed asset prices up and lower expected returns. Arguably, the flip side of the expected low returns on safe assets are the stratospheric prices of real estate, memes stocks, and cryptocurrencies.
In other words, the Fed’s policy and the unique pandemic economy are major contributors to the extremely low rates in the summer of 2021. But it doesn’t help that they come at a time when much of people are eager to save – and that part is not going to change anytime soon.