A penny saved is a penny earned. This adage has been around forever but is just as true today as it’s ever been. In fact, in our current investing environment, it can sometimes be easier to save a penny than it is to earn one through investing. The prevalence of low-interest rates has made saving much more valuable for anyone who wants to build, or keep enough wealth to retire comfortably.
What We Learn From History
Historically, falling interest rates were profitable for bond investors, whereas rising rates lowered bond returns. When interest rates fall, bonds have returned an annual average of 3.6%, which drops down to only 0.3% when rates are increasing. The researchers calculated in the effects of inflation to get to these numbers. This makes rising-interest rate environments a challenge for both stock and bond investors.
Economists have found that since 1913, stocks have performed well during periods of falling interest rates, but barely deliver a positive return when interest rates increase.
Where We Are Today
For the first time in our nation’s 149-year history, the yield on 10-year Government of Canada bonds fell below 1%. (1) The low rates we are experiencing right now are not unprecedented, as these rates were common in the 1940s and 1970s.
The major difference between now and then is the relationship between low rates and inflation. Often, low bond yields are accompanied by high and unexpected inflation, as was the case in the 1970s. However, our current low-interest rate environment was purposefully created by central-bank policies in an attempt to stimulate growth in the economy.
While it is true that spending is generally healthy for an economy, these low interest rates are taking a toll on investments, like guaranteed investment certificates (GICs), that many retirees and others on fixed incomes rely on.
Take a look at this example of what is happening with a five-year GIC. In 2006, the income generated on a GIC was almost double what it is today. Based on today’s average rate of 1.76%, (2) a $100,000 investment only made $1,760, compared to $3,200 in 2006. And with the consumer price index hovering around 1.45%, (3) GICs are barely bringing in any profit.
The Appeal Of Alternative Investments
Historically, the asset class of alternative investments has performed reasonably well where traditional asset classes have suffered in a rising interest rate environment. This is partially due to the fact that the various underlying investments have a low correlation with equities and fixed income assets. Generally, many of the same risk tolerances can be created to suit various clients’ values. This is one possible option to look into.
The low rates we see now will not last forever, and are already forecast by industry experts to rise again soon. As we saw with the historical figures, rising rates mean dismal returns for both stocks and bonds. With future interest rate increases inevitable, investors will not be able to depend on the markets to build their wealth in the same way as they have in the past.
What This Means For You
Investing is said to be a partnership between you and the markets. Sometimes, as in the 1980s and 1990s when both stocks and bonds were soaring, the markets did most of the work. In our current investing environment, the markets have decided to take a break, requiring you to take over the bulk of the work.
What does that mean? It means that you need to rely on saving, rather than returns, to preserve or even grow your wealth. In this environment of substantially lower returns, saving more and spending less is the order of the day if you want to continue to grow your nest egg in order to sustain your lifestyle into retirement.
How We Can Help
At Black Spruce Financial, we understand the complexities of the current investing environment and your need for a sustainable income in retirement. We can help you calculate how much you need to be saving right now in order to maintain your lifestyle after you stop working. Together, we can develop a plan that will enable you to live the life that you want during your golden years. Contact me at 416-553-5004 or gino@blacksprucefinancial.com.
About Gino
Gino Scialdone is a financial advisor and the owner of Black Spruce Financial, an independent wealth management firm serving independent business owners. Having grown up in a family business and owning a business himself, Gino has a unique understanding of the challenges and needs business owners face. Offering a comprehensive array of wealth management and financial planning services, he strives to provide sound and creative strategies that meet a business owner’s short and long-term needs. Based in Toronto, Gino serves clients throughout the greater Toronto area and southern Ontario. To learn more, connect with him on LinkedIn or visit www.blacksprucefinancial.com.
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(1) http://www.canadianbusiness.com/investing/the-low-interest-rates-forever-portfolio/
(2) http://www.financialpost.com/personal-finance/rates/gic-annual.html
(3) http://www.inflation.eu/inflation-rates/canada/historic-inflation/cpi-inflation-canada.aspx