What Could Near-Zero Interest Rates Mean for Investors?

THE ROCK-BOTTOM INTEREST RATES created when the Federal Reserve (Fed) acted to bolster the economy in the spring of 2020 are likely to be with us for some time.  “We expect the Fed rate will stay at or near zero even once the economy has started to improve,” says Michelle Meyer, head of U.S. Economics, BofA Global Research. Maintaining its key interest rate low, the Fed believes, will help keep liquidity flowing, supporting financial markets, businesses and consumers as the nation recovers from the economic impact of the coronavirus.

For the average American, low rates may mean lower borrowing costs. “All else being equal, Fed rate cuts can reduce your cost of debt,” Meyer says. Yet they also create challenges for other areas of your financial life, including investing. Below Meyer and Chris Hyzy, Chief Investment Officer for Merrill and Bank of America Private Bank, offer insights on navigating an extended period of extremely low rates.

Stocks vs. Bonds: Looking for Growth

Under usual economic conditions, bonds such as U.S. Treasurys may provide reliable earnings for retired investors and others seeking income from their investments. Yet because Treasury rates are tied directly to Fed rates, bond income may be hard to find right now. Rates for 10-year Treasurys  have dropped below 1% and are expected to rebound only slightly during the rest of this year, according to BofA Global Research.

But it’s important to remember that the purpose of rate cuts is to spur economic growth—and that often boosts stock prices. “Especially in a low-rate environment, stocks can be a crucial way to invest for growth,” says Hyzy. At a time when average dividend yields for stocks on the S&P 500 are several times the yield on 10-year Treasurys, the income potential may be worth the added risk that comes from investing in stocks.

So, What Can Investors Consider Doing?

In a low-rate environment, Hyzy says, you may want to work with an advisor to assess your ability to increase risk slightly and take a disciplined approach to shifting some of your fixed income to the equity side of your portfolio. You might, for instance, consider investing in stocks of large, high-quality U.S. companies that pay regulars dividends. Some sectors—including health care and pharmaceuticals, technology (robotics, artificial intelligence, 3-D printing) and e-commerce—are experiencing a surge in demand that may continue even after the pandemic ends, adds Hyzy.

Keep in mind, however, that low interest rates are not necessarily a reason to remove bonds from a portfolio. They remain an important means to balance equity risk. Corporate bonds, which tend to have higher yields (along with higher risks relative to other bonds), may be an option for investors seeking income. “You might also consider a bond laddering strategy,” says Hyzy. “It could help you manage the risk of low rates now while being prepared if they rise unexpectedly.” A bond ladder normally consists of equal amounts of bonds or bond funds with a range of maturities, from short-term to long-term. As each rung of the ladder matures, the proceeds can be reinvested in a new long-term bond at then-prevailing and potentially higher interest rates.¹

“The best course is to remain focused on your long-term goals and on diversification across and within asset classes,” Hyzy says. Your advisor can help you review your investments and determine whether you need to make adjustments. In fact, now may be a good time for a conversation about all of your important financial goals and to consider whether your portfolio is properly balanced to pursue those goals in today’s environment—and beyond.

While extremely low rates may mean you have to review and rethink some of your current investment strategies, “keep in mind that the purpose of those policies is to help stabilize financial markets, boost economic recovery and increase consumer confidence,” Meyer adds. While that process is underway, you may find that low rates offer both investment opportunities and some ways to better manage your debt.