Lower Rates Leads to More Diversity

Lower interest rates encourage an increase in mortgage applications and other loans, which further increases the total debt of the nation. The lowering of interest rates in the 1990s stimulated the economy and thereby improved stock market returns. With the stock market debacle of 2000, the fed lowered interest rates even more. This protected the banks from losses or bankruptcy.

This action was also meant to encourage speculation in both stocks and real estate. When savings are paying low interest, people look for a place to put their money where they will receive a higher yield. If they are not earning enough in CDs, money markets or bank savings, the stock and bond market is the place to look for a higher return. This action increases the volume of activity in the stock and bond market.

Whenever you turn to an investment that has daily variable pricing, you take a chance your account will lose money as well as earn money. After a period of rising markets, the prices of stocks and bonds will tend to go up and become more than the actual value of the company. When investors believe the price is too high, they will sell. This may not last very long if the price comes down enough for many to believe it is time to start buying the companies and mutual funds with lowered share prices.

As long as interest rates remain low, the public is feeling as though they can afford mortgages and save on their monthly payments.  Even though statistics are saying more people are paying off their debt, there is a huge amount of equity (money not yet paid back) that the banks own.

We say we own a house but actually this is not true until the mortgage is completely paid off. The bank owns the property. The bank has loaned the money to the buyer of the property by creating the money in the borrower’s bank account. The bank is earning interest on the loan and if the mortgagee defaults, the bank can sell the property and keep all the interest received. Therefore, by lowering interest rates, banks are able to issue more loans and earn more money.

The troubling part for the investor is the lack of access to a risk free rate of return, one you can depend on to produce interest that allows you to have enough income or to increase your savings.

Until interest rates rise, we will be looking for value in the stock and bond market. This means we need exposure to a diversity of investing products. There will be times when the stock part of your portfolio will increase or decrease and times when the value of more stable investments will rise or fall. Having the variety of stocks and bonds will help keep your portfolio from the acute ups and downs of the market.



 

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