The Zero Interest Rate Problem

The Zero Interest Rate Problem

Falling Interest RateSome things never change. In our day of the thoroughly modern Federal Reserve Bank, Mr. Market hangs on every word, every nuance, every implied hint from the Chairperson.

What I understand is this: Although the Fed will continue to buy fewer bonds from (lend money to) the US government each month, it remains committed to ensuring that the federal government, hedge funds or others who don’t really need money can get it at nearly zero percent interest. I am sure there has been some other acronym spelled ZIRP, but to me, it means the Zero Interest Rate Problem.

The rest of us who don’t want debt and are doing just fine without it will just continue to suffer on our side of the equation. We will not make any interest on money we lend to banks in the form of checking deposits, money market funds, CD’s and the like.

So, how can you do a little better without chasing dangerous high yields or betting the farm on equities? I have explained that owning long maturity bonds is or will be hazardous to your wealth whenever (not if) interest rates begin to rise in earnest.

This week I saw my first example of this with a CD. A client transferred in a CD of American Express Centurion Bank maturing in May, 2018. It is paying 1.2 percent per year and it probably was purchased last May as a five year CD. It is worth now only 98.3 percent of its face value because the interest rate for the same amount of money for the remaining term is higher. So the client has lost part of his principal. This is not good.

On the other hand, some watchers are saying that the stock market is too high and must come either crashing down. At best, they predict it will travel sideways for a year or two to digest the gains of the past five years. Not very satisfying either.

Here are the keys. First, true emergency money should not be at any great risk, no matter how little you make from it. Its entire existence and importance comes from its availability with almost no notice. This purpose will generally require anywhere from several thousand to tens of thousands depending upon your lifestyle and potential risks.

After that is satisfied, look for very short term bond funds which pay a couple percent interest but have very little principal risk from future higher interest rates. Look at hybrid mutual funds that consist of mostly short term bonds but have a smaller percentage of stocks for some growth.

American Century here in town has an interesting one, the One Choice Portfolio Very Conservative Fund (Investor Class), symbol AONIX. It is a mixture of other funds in their stable recently reporting 64 percent in bonds of various kinds, 25 percent in stocks, and 10 percent in cash.

AONIX has earned at least 4 percent in each of the last four calendar years and is up 1.9 percent in the first quarter. It usually pays a quarterly dividend and appears to have dropped only 2 or 3 percent in the worst market drops of the past several years. We at Stewardship Capital have not and do not own any of it now, but it appears to be worth a try.

(Intended for general audience and not as specific advice. Past performance is no guarantee of future results. Statistics obtained from TD Ameritrade Institutional, Inc. and Worden Brothers TeleChart 2000 Funds, 2014.)

April 4th, 2014|Categories: Economy, Government, Investment Management, Stocks|