Low rates, inflation and your finances

By William Dostman III The Daily Record Newswire Interest rates in the United States have been, and will continue to be for some time, exceptionally low. The Fed has already given the indication that they plan to keep the federal funds rate near zero through late 2014, as they attempt to reinvigorate the U.S. economy. This decision, along with several other factors, has resulted in depressed interest rates in everything from savings accounts to mortgages. While U.S. Treasuries and money market funds offer principal safety, their current interest rates are paltry and even negative in real terms. Real interest rates are the current rates after being adjusted for inflation. For example, if your savings account currently pays you 0.25 percent and inflation is 3.00 percent, your real rate of return would be -2.75 percent. The dollar figure of your savings account will increase over time, but those dollars will continue to buy you less and less. Though inflation is currently at reasonable levels, between two and three percent, it is likely that it will increase in the coming years. The Fed has a dual mandate of maximum employment and price stability. Presently, we are considerably below maximum employment, though prices have been fairly stable. Given the severity of our most recent recession, the persistently high unemployment rate, and the background of Fed Chairman Ben Bernanke, I am convinced that the Fed will err on the side of improving growth and employment at the expense of increased inflation. For individuals, this has several implications. Sadly, those that are on fixed incomes will find their purchasing power diminished as time goes on and consequently, their standard of living will be reduced. This is especially significant given the surge of baby boomers that will be entering retirement in the coming years. From an investment perspective, the "safe assets" that so many people have flocked to over the past couple of years will likely produce unsatisfactory returns going forward. As I mentioned previously, real rates of return on cash make it a guaranteed loser. The bond market has become a safe haven for many, but the bond bull market that began in the early 1980s appears to be nearing its end. When rates begin to rise again, many individuals will be shocked at the losses incurred in their bond holdings. Given the current fiscal state of the U.S., future inflation seems inevitable, and the key going forward will be to increase the value of your assets in real terms. Some investments that tend to do well in an inflationary environment include stocks and hard assets, such as commodities and real estate. Regarding real estate, if you are currently in a position to do so, purchasing a home with a 30-year fixed rate mortgage appears to be a great decision. In many parts of the country, home prices remain depressed, and mortgage rates are still near all time lows. For the same reason that holding cash is presently unattractive, having fixed rate debt is attractive. Similar to the earlier example, if you take out a 30-year fixed rate mortgage at 4.00 percent and inflation is 3.00 percent, your real mortgage rate is only 1.00 percent. If inflation increases, your real mortgage rate decreases. In conclusion, the financial environment is such that savers are being punished and debtors are being rewarded. At the current rates, you want to be a long-term borrower (i.e. 30-year fixed mortgages) not a long-term lender (i.e. 30-year U.S. Treasuries). Review your investments, and make sure that you are prepared for the "real" world ahead. ---------- William Dostman III is senior domestic equity manager for Karpus Investment Management, a local independent, registered investment advisor managing assets for individuals, corporations, nonprofits and trustees. He can be reached at (585) 586-4680. Published: Thu, Mar 29, 2012