Across the European Union and the USA we are faced and struggling with ridiculously low interest rates. The argument by central bankers and politicians alike is that it forces banks to lend more money to businesses and deposit less money with the central banks. Their arguments hold true: business lending is at a very low point with many small and mid-sized companies finding themselves in dire need for bank loans.
While the low interest rates are highly advantageous for those amongst us planning to take out a mortgage; it is very disadvantageous for those who want to save. A friend recently told me that he will make a few expensive purchases from electronic gadgets to clothes and enjoy some luxurious holidays, as he’d rather spend his money than leave it in his low-interest account. I was intrigued by his argument that spending all his hard-earned cash is better than leaving it in a bank account where he hardly earned any interest.
It’s consequently better to splash your money, right?
From an earning perspective, it is of course not sensible to put your money into an average savings account at 1%. $/€/£ 10,000 earn you a laughable $/€/£ 100 per annum. That hardly pays for a nice dinner out with your loved ones. Thus, my colleague was right, from an earning perspective at least. But what about the mid- and long-term? If you don’t spend your money on some unnecessary item and keep up your savings rate, the near-future benefits will very much compensate you for the current painfully low interest rates.
When the rates pick up again, and they will soon enough, you will be in a superb position to reap the benefits. The Fed’s indeed already contemplating a base rate increase in the next few months. The Bank of England is also following suit. And despite recent decisions by the ECB, they will also have to raise interest rates eventually. And once that process starts, the increases will likely to be very steady. As a consequence of the various rounds of quantitative easing, the central banks need to eventually suck the massive amounts of money out of the markets.
And this is when the savvy financial sailor is ready to cash in.
Investing while interest is down
If you are saving, but feel lost with regard to where to best put your money for a relatively good return; remain patient. Don’t fall into the long-term commitment trap just to earn a few extra interest points. Stick to short-term instruments. Anything up to 6-12 months will work in your favor, as it will take the central banks, and particularly the retail banks, some time to increase the base rates. You may have noticed that retail banks always need some additional time to pass on interest rate increases. These few weeks or couple of months your bank needs to up your interest rates on your saving account should still not steer you towards locked long-term savings accounts.
The Fed and the Bank of England will probably increase their base rates within the next 6-12 months and that should also be your horizon for locking away your money into some type of account.
Don’t lock yourself in for the long-term
But saving vehicles locking your money in for 2, 3, or even more years during a period, when most fixed-term accounts offer historically low rates, will put you in a position of inflexibility when things turn, and they certainly will. Locked up capital will prohibit you from benefiting from interest hikes. If rates increase before your saving vehicle matures, you will lose valuable time during which your money can grow.
Truth be told, most longer term saving vehicles offer relatively little or no substantial premium over accessible or short term accounts. Thus, the risk of locking in money for a prolonged period without the flexibility of shifting investments may not provide much of a financial advantage.
There are many other options if you are seeking better returns for the time being; some riskier than others such as shares, bonds, or peer-to-peer lending. If you prefer not to be exposed to higher risks, at least hold on to your hard-earned cash. And even if you invest some of your money, it is a good idea to keep some cash to be able to react to future opportunities when central banks raise the interest rates.