This Is a Terrible Time for Savers

If you are saving money for the future, somehow, you had better be prepared to lose some of it.

It is the involvement of today’s upside down world in financial markets. The combination of high inflation, strong economic growth, and very low interest rates means that “real” interest rates – what you can earn on your money after accounting for inflation – are inferior to what they have been in modern times.

This result is the result of a glut of global savings and the extraordinary efforts of the Federal Reserve to bring the economy back to health. And that means that the choice for a saver is difficult. You can invest in safe assets and accept a high probability of getting back less, in terms of purchasing power, than what you invested. lose money if market sentiment turns negative.

“For risk-averse people, they have to get used to the worst of all possible worlds, which is seeing their small pool of capital shrink in real terms from year to year,” Sonal Desai said, Chief Investment Officer of Franklin Templeton Fixed Income.

Inflation above interest rates is good news in certain circumstances: if you can borrow money at a fixed rate, for example, and use it to make an investment that will add something of value over time. whether it is a house, farmland or equipment for a business.

But consider the options if you’re not in that position and saving money you expect to need in five years – for a down payment on a house or a child’s college expenses.

You can keep the money in cash, for example through a bank deposit or a money market mutual fund. Short-term interest rates are at or very close to zero, depending on where the money is specifically parked, and Federal Reserve officials plan to keep rates there for perhaps a few more years. Inflation has been 4-5% over the past year, and many forecasters expect it to slowly decline.

Or, you can buy a safe treasury bill that matures in five years. The bond’s annual yield on Friday was 0.77%. This means that if annual inflation is higher than this, the purchasing power of your savings will decrease over time. The most profitable federally insured bank certificates of deposit over this period only offer a little more, a little over 1%.

If you are particularly concerned about rising prices, you can buy an inflation-protected Treasury security, a government-issued bond that is indexed to inflation. The five-year performance of TIPS? A negative 1.83%. This means that if inflation were 3% per year, your equity would only earn 3% minus 1.83%, or 1.17%. In return for protection against the risk of high inflation, you have to tolerate a loss of almost 2% in purchasing power each year.

Then again, you could take a little more risk and buy, say, corporate bonds. But that adds the risk that the companies that issued the bonds will default – and that’s still enough to roughly keep up with expected inflation. (A BBB-rated corporate bond index returned just 2.19% at the end of last week.)

The stock market and other risky assets offer potentially higher returns, with some degree of inflation protection. The profits of the companies that are the basis of stock valuations are skyrocketing, one of the reasons the major indexes have hit record highs in recent days. But with that comes the pervasive risk of a massive sell-off – tolerable for people with long-term investing but potentially problematic for those with shorter horizons.

This environment of extremely negative real interest rates leaves those whose job it is to analyze and recommend bond investment strategies with few good options to advise.

“It’s even hard to make a case for fixed income at these levels,” said Rob Daly, director of fixed income at Glenmede Investment Management. “It’s the old” pennies in front of a steamroller business. “”

That is: someone who buys very low yielding bonds receives low interest in exchange for taking the substantial risk that higher inflation or soaring rates could more than wipe out the gains (when interest rates rise, existing bonds lose value).

For these reasons, Daly recommends that investors allocate more of their portfolios to cash. Yes, he will pay almost no interest, and therefore the saver will lose money in inflation-adjusted terms. But that money will be ready to be invested in riskier, longer-term investments whenever conditions become more favorable.

Likewise, Rick Rieder, director of global fixed income investments at BlackRock, the huge asset manager, recommends that mid-term investors build a portfolio that combines stocks, which offer upside potential. corporate profits, with cash, which provide security. even at the cost of negative real returns.

“It’s surreal,” Mr. Rieder said. “It’s one of those times when the fundamentals are completely detached from reality. The current situation of real rates makes no sense compared to the reality in which we live.

The Fed, in addition to keeping its near-zero short-term interest rate target, buys $ 120 billion in securities each month as part of its quantitative easing program, and is only now starting to talk about plans for it. reduce these purchases. This has the effect of putting a huge buyer in the market which drives up the price of bonds, and therefore lowers rates.

Fed officials believe that the strategy of maintaining an eased monetary policy even as the economy is well under way in its recovery will help quickly put the US labor market back to health. The aim is also to establish credibility that his 2% inflation target is symmetrical, meaning he will not panic when prices temporarily exceed that target.

Many people involved in market strategy are far from happy with this approach and the consequences for potential investors.

“Nominal yields are low because of what the Fed is buying,” said Ms. Desai of Franklin Templeton. “It’s ridiculous given where we are” with growth and inflation.

At the same time, Americans have racked up trillions of additional savings during the pandemic, money they are putting in all kinds of investments, which has pushed asset prices up and returns. expected to decline. Arguably, the flip side of the expected low returns on safe assets are the stratospheric prices of real estate, memes stocks, and cryptocurrencies.

Globally, demographic trends related to the aging of the huge baby boom generation are causing savings to surge. Gertjan Vlieghe, a senior official at the Bank of England, has shown that the pattern of retirement savings evident in Britain and in advanced countries indicates that interest rates remain low.

“We are only about two-thirds away from a decades-long demographic transition that is affecting interest rates,” Vlieghe said in a speech last month. “The key mechanism is not that older people have lower savings rates, but rather that, as people get older, they hold higher levels of assets, especially safe assets.” then slowly spend those savings when they reach retirement age.

This helps explain why interest rates have been consistently low in major economies – in Europe, the United States, and Japan in particular – for years, even at times when those economies have performed relatively well.

In other words, the Fed’s policy and the unique pandemic economy are major contributors to the extremely low rates in the summer of 2021. But it doesn’t help that they come at a time when much of of the world are eager to save – and that’s not going to change anytime soon.