Income Series Part Two
3 benefits of lower interest rates
Written By: Allison Schmidt, Financial Advisor, CFP®, CPA
Welcome to Part Two of my two-part income series looking at interest rates and the opportunities and challenges in each environment. In Part One, I looked at the current higher interest rate environment, Part One: 3 benefits to higher interest rates . Here I’m going to discuss the flip side and focus on low interest rates and what happened during the most recent low interest rate cycle.
A low interest rate environment was a place we all got very comfortable until the beginning of 2022 when the Federal Reserve began increasing interest rates to the 5.5%^ rate it is today.
The environment that we benefited from had some challenges for conservative investors, who were unable to find safe consistent returns to beat inflation. Despite record low inflation at under 2%, safer investments, such as government bonds, cash, and AAA corporate debt wasn’t able to keep up consistently without taking on significant maturity (long term bonds: 10, 20, 30-year bonds).
While lower interest rates were challenging for the safer piece of the portfolio, there were a couple benefits specific to other pieces of your balance sheet.
- Borrowing was historically cheap: ‘Why use my money when I can use yours?’. Borrowing became a low-cost option for investors to expand their portfolios. Lower interest rates make borrowing cheaper, encouraging both consumers and businesses to take loans. For consumers, this meant buying homes or cars, while businesses might invest in new equipment or expansion, potentially boosting economic growth.
Housing Specific: Housing went through a prolonged decline coming out of the 2008 recession. 2008-2011 was a pretty brutal 3 years for housing, with the US Home Price Index dropping as much as -18.48%*. This led to an extended period of less housing starts or home building, US Housing Starts dropping as much as -51.3% during the recession*. Now enter historically low interest rates and this combination created a perfect storm for increasing home prices…less homes available, more money available (rates are low, you can buy a more expensive home for the same monthly payment), equaled climbing prices. Then throw in demand with the widely accepted idea that Millennials were never going to move out of the city and start families. People, economists, thought this group (me and my friends) was different…no kids, no cars, no big homes. This gave some justification to why less houses in the suburbs would be okay, but that’s not what happened. We just started later. Instead of having kids in our 20s, we had kids in our 30s. Instead of buying big houses and cars in our late 20s when our kids were young and we needed good schools…you guessed it…we did it in our 30s. The demand didn’t go away, it just came later, and with potentially larger pockets or cash flows because postponing family formation prolonged single or DINK (Dual Income No Kids) years where Millennials may have had the ability to save more. What has happened in housing is a slamming together of many forces started by the Great Recession and a reduction in inventory, furthered by lower interest rates, and exacerbated by a misread of the largest generation. The result… a staggering 106.4% increase in home prices over the 10 year period of January 1, 2014 through January first of this year (2024).* Low interest rates, and the gradual decline of mortgage rates while home prices rose helped to keep housing more affordable. Interest rates effect on housing affordability is arguably the most widely felt interest rate impact. For most people, the most debt they will ever take-on is a home mortgage.
- Higher Asset Prices: Houses weren’t the only assets that increased through the low-rate environment. Low rates often contributed to higher prices for other assets like stocks. Cheaper borrowing costs make it easier for people to buy homes and for investors to buy stocks on borrowed money, potentially pushing up prices. As of the end of the 1st quarter in 2024, the S&P 500 Price Index (SPX) has increased 676.7% since the low was set on March 9th, 2009.*. A welcomed move in the US index coming out of the Great Recession where the S&P 500 fell by over 50%.
- Stimulated Economic Growth: When money is more easily available, there is a lower barrier to entry in terms of spending. By making borrowing cheaper, low interest rates encourage spending and investment. This can help an economy recover from downturns or stimulate slow growth by increasing production, jobs, and consumer spending. This was evidenced by a drastic reduction in unemployment with the US Employment rate going from a high of 10.10% (Oct 2009) to where we sit today at 3.80% (Mar 2024)*. In the depths of the 2008 Great Recession, we needed to stimulate economic growth and reducing rates was a piece of a larger strategy to jumpstart the economy.
There were several benefits that we saw with lower rates over a period of time. A combination of a number of factors can’t all be credited to lower interest rates. However, as a general, there are a couple of low-rate strategies that we will again be recommending when we have the next lower rate leg of the interest rate cycle. Lock-in those low rates, depending on your risk profile, extend the term, and keep durations/maturities on your bonds and fixed income short to lessen a principal decline when rates reverse course.
Interest rates are just one aspect of many in terms of why and how markets will react. We believe there are both opportunities and drawbacks to a higher and a lower interest rate environment. Check out Part One of this Income Series: 3 benefits to higher interest rates for a more in-depth look at the current environment and a couple strategies to consider.
For our thoughts on the real estate market through the low-rate environment check-out our blog post from February of 2021, The Denver Real Estate Market has Gotten Expensive…right? The math behind real estate (for most people).
*ycharts.com
^CNBC.com
Securities offered through LPL Financial, Member FINRA/SIPC. Investment advice offered through Higgins & Schmidt Wealth Strategies, a registered investment advisor and separate entity from LPL Financial.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results.
CDs are FDIC insured to specific limits and offer a fixed rate of return if held to maturity, whereas investing in securities is subject to market risk including loss of principal.
There is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio. Diversification and asset allocation does not ensure a profit or protect against a loss. Stock investing involves risk including loss of principal.
Bonds are subject to market and interest rate risk if sold prior to maturity. Bond values will decline as interest rates rise and bonds are subject to availability and change in price. Rebalancing a portfolio may cause investors to incur tax liabilities and/or transaction costs and does not assure a profit or protect against a loss.
