The Lesser Recognized Destructive Results of Low Curiosity Charges

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The Lesser Known Negative Effects of Low Interest Rates

Are they good or bad? It really comes down to who asks.

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December
7, 2020

5 min read

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When someone asks me a business or economic question, the answer is almost always, “It depends.” I don't say this because I don't want to share the answer, but because it really depends on the position someone is in For example, a common question is, "Are low interest rates good or bad?" Well that answer would be shocking, it depends. Low interest rates are generally good for people buying or refinancing a home, businesses in need of funds to invest, and investors. On the other hand, however, there is a group of people who actually do not benefit from low interest rates – retirees and retirees.

A pension crisis has been looming for some time. Add to this the current global pandemic and the 20 million plus baby boomers who are about to retire, and unfortunately the timing couldn't be worse. We have been warned about this possibility for decades, but unfortunately the crisis now seems to be getting closer. Factors such as the massive conversion of retirement plans into 401,000 plans – which shifted retirement risk to workers – and the 2008 financial crisis, in which state and local funds lost 35-40% of their value, have contributed to the looming threat. Moody's investor service only confirmed that assessment two years ago in 2018 when it was reported that public pension funds were underfunded by $ 4.4 trillion. Unfortunately, a low interest rate environment would make it even more difficult for these funds to recover their losses. Fortunately, there is one way to invest that prevents retirees from experiencing the negative effects of a low interest rate environment: building a rental portfolio.

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When someone is ready to retire, he or she should expect payment from three possible sources: social security, retirement plan, and savings account, which includes both 401,000 plans and IRAs. I like to think of these sources as a three-legged stool as they all work together. In this article, however, I will focus on retirement planning as this is the most negatively affected by a low interest rate environment.

When it comes to retirement savings, there are typically four options people can use to convert their retirement savings into a stream of income: bond ladder, asset withdrawals, pension and rental portfolios (which are typically less discussed than the first three). In a normal interest rate environment, it is possible to put together a portfolio of bonds with different maturities, known as a bond ladder, which generates a stream of income. In a low interest rate environment, this is not a sensible option.

The asset withdrawal method (also known as the 4% rule) works when you are investing your money in the stock market. You deduct 4% of these funds annually as retirement income. When you consider that the average return for the stock market is typically 9%, it seems safe in the long run. It all just depends on how well your stock is doing. During times when your returns are below your payout rate, you may need to cut your spending.

When it comes to an annuity, I'm not a big fan of using it for sales, and that's mainly because the payout percentage is very low compared to the premium. In a low interest rate environment, the payout percentage is reduced, making your payout even less attractive. To verify this, I did some calculations and estimated that a drop in interest rate from 4% to 2% could mean a whopping 20% ​​reduction in the payout (assuming everything else stays the same). So if you are relying on an annuity to turn your retirement savings into a stream of income, a low interest rate environment is far from ideal.

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The rental portfolio is my favorite way of converting retirement assets into streams of income. Not only does it provide a monthly passive income, but the rental income is adjusted for inflation, the property increases in value over time, and you can build up more equity that can then be passed on to your children. This type of investment offers even better returns in a low interest rate environment because it lowers financing costs. The fact that rental property investments have significant tax benefits unlike other forms of investment is the reason I recommend everyone invest in turnkey rental properties as early as possible.

While most people assume that low interest rates are always positive, it is important to note that "it depends on the situation". As mentioned above, low interest rates, especially when it comes to retirement planning, can actually be detrimental. On the flip side, rental portfolios are a great way to convert retirement savings into sources of income that generate higher returns with low interest rates.