The other day a reader emailed me to ask “I’ve read your advice in the Investment Workshop about owning a mix of stocks and bonds, but that was back when bonds actually paid something. With interest rates in the gutter, does that advice still hold?”
Great question. Let’s dig into this a bit, shall we?
During the last economic downturn in 2008, one of the key decisions that helped save the economy (or rather, prevented it from falling off a cliff even more) was that central banks around the world chose to drop their key lending rate to near-zero. This had a stimulative effect on the economy because it lowered the cost of borrowing, allowing more businesses access to capital to stay afloat, and simultaneously encouraged investors to pile their money into the stock market since bonds were paying so little.
So when the pandemic hit the US in February/March, dropping interest rates to zero was one of the first things the US central bank did. The Canadian central bank followed suit, as did the European Central Bank (though that one was already pretty close to zero already).
So now interest rates all around the world are sitting at nero zero. Savings accounts have gotten massacred. Government bonds are paying next to nothing. Hence the questions filling up my inbox. So how should our readers react to this new zero-interest rate environment both in their portfolios and in their life?
Here are a few of my thoughts on this.
Don’t Buy a House and Get Into More Debt
FIRECracker and I don’t really write about Home Boners that much these days, because there’s only so many ways we can say “you’re all idiots” without it becoming monotonous, but one of the most baffling and most frustrating things that have happened during this pandemic is that after a frozen spring where everyone was locked down, the summer has seen a massive rebound in the housing market.
People have realized that lower interest rates means the bank will lend them more money, and have reacted by going on an epic home-buying orgy, sometimes getting into bidding wars over houses they haven’t even visited because social distancing has prevented traditional open houses from happening. And in the process getting into even more debt that will weigh on them for the rest of their lives, especially when interest rates inevitably begin their slow climb back up.
This is why I don’t even bother trying to give advice to Home Boners anymore. They’re hopelessly stupid. They’re like financial lemmings, constantly seeking out the highest possible cliff they can find to throw themselves off of. Economy doing well? Buy a house! Economy in the shitter? Buy a house! A once-in-a-lifetime pandemic preventing you from even seeing any properties? Buy a house!
FIRECracker and I have decided that if we ever need to settle down in one place and stop travelling, one of us should get a real estate’s license and just sell homes to idiots. Home Boners are too stupid to have money and are just going to hand their life savings over to someone else anyway, so we may as well take some of it.
Refinance Any Debt You Already Have
That being said, if you already have debt, whether it’s in the form of credit card debt, a mortgage, or student loans, now is a great time to try to lower your interest rates on them.
I recently applied for an unsecured line of credit, you know, for fun, and I got an interest rate of under 5%. That same LOC would have been 7-8% at the beginning of the year, so that’s pretty huge!
So anyone with a balance on your credit card card can immediately bring their interest rate down by opening up a LOC and paying off their credit card with it. Boom! 20%+ interest down to 5% in 5 minutes!
Same goes for car loans or student loans. Check with your lender first to see if you can refinance. If not, find another lender offering a lower rate and retire your high-interest loan with a shiny new low-interest one. Paying 8% on a student loan is SO 2019!
Mortgages can be a bit trickier. Depending on the type of mortgage you have, you may not be able to change the interest rate, but check with your bank about refinancing options. You never know, and it never hurts to ask, right?
Increase Your Equity Allocation If You’re Accumulating
Now let’s talk about investment portfolios. Interest rates sitting at zero have definitely benefitted equities, partially explaining why stock markets are positive for the year even as unemployment is sitting above 10%. Fixed incomes? Not so much.
Ultrashort bond funds, for example, which we used to use to store the dividends we receive over the year, are now pointless. They were a low-risk way of eking out some interest income on my cash in the range of 1%-2%, but now they’re not paying anything at all. What’s the point?
That being said, bond index funds like BND (if you’re American) or VAB (if you’re Canadian) that hold lots of different types of bonds including corporate bonds are still yielding around 2.5%. That’s not as good as it used to be at the beginning of the year, but it’s not zero like the ultrashorts.
Plus, bonds have the additional effect of reducing your overall portfolio volatility, so it still makes sense to own these in your portfolio.
Though, arguably, maybe not as much of it.
If you’re still working and accumulating money in your portfolio, I’d consider bumping up your equity allocation by 5 or 10 percent. There’s just better value in equities right now.
Lean More Heavily On The Yield Shield If You’re Close To Retiring
If you’re close to retiring or about to retire, first of all, great timing.
It may not feel like that right now with everything shuttered and with borders closed, but 2020 saw the end of a decade-long bull market that lasted from 2009 to 2019. And the stock market has already recovered from the recession because of all this central bank stimulus. That means that in all likelihood, the next decade long bull run is just starting, so if you’re just closing in on your FIRE target, you’re positioning yourself for a retirement that’s going to be up-and-to-the-right out of the gate.
Of course, it’s also a zero-interest rate environment, which is not so good if you now need income from your portfolio. The traditional solution of swinging towards bonds is not going to work if those bonds don’t pay you diddly.
But we have a solution here: The Yield Shield.
Even now, there’s still places to find income, and those places happen to be in areas that we already wrote about when we introduced our Yield Shield strategy. Alternative, higher yielding asset classes like Preferred Shares.
As of this writing, CPD, which is the Canadian Preferred Share index that we used to own, is still paying 5.3%.
So it’s still possible to build an income producing portfolio to live off of in retirement. The big difference is, that when I wrote that Yield Shield series those alternative assets were meant to be held alongside traditional bonds. Now that those bonds are paying next to nothing, you may have to build the fixed income side of your portfolio entirely with these alternative assets, at least until interest rates normalize in a few years.
So there you have it: Millennial Revolution’s guide to personal finance in today’s zero interest rate environment. Don’t get into more debt, refinance the debt you have, increase your equity allocation if you’re accumulating, and lean on the Yield Shied if you’re about to retire.
What do you think? Is there anything you’re doing differently with your finances? Let’s hear it in the comments below!
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