August 24, 2020
The good news – you didn’t just wake up in the movie The Matrix as a battery. The bad news – you are living in a sort of “Matrix reality” void where interest is very hard to find. Money invested in savings accounts, bank CDs, government and corporate bonds is now earning virtually nothing. With income generation still a top priority for many investors, super low interest rates have led to many similar conversations addressing the statement: “I need more income.”
There are two major types of investments: one involves owning something, and the other is based on lending money. Ownership obviously provides the benefit of any increase in value and the downside of any loss in value. Lending money, instead, is an agreement based on a promise from the borrower, to pay a stated interest rate, and eventually the full amount of the loan. There is no real upside on a loan for an investor beyond receiving an interest payment while the loan is in place, and the entire principal by the end of the loan.
Just last year an investor could earn 2% on what might be the safest investment in the world, US Treasury bills. Today’s rate is only 0.07%. What a difference: if I invest $1,000,000 at 2%, I earn $20,000 in a year, while at 0.07%, the amount earned is $700.00 per year. The world of lending includes two simple guidelines. First, the higher the creditworthiness of a borrower, the lower the interest they pay. The second is the longer the length of a loan, the higher the interest rate should be. More time means more risk of something reducing my borrower’s ability to repay me.
Below are some current examples of the low/no interest rate environment we are experiencing (and yes, you must pay to hold German, Japanese or British government’s bonds):
|Investment||Length of Bond/Loan||Risk/ Comment||Interest Rate||One Year’s Interest|
|German Bund||5 years||Low||-0.69%||($690)|
|Japan Note||5 years||Low||-0.08%||($80)|
|British Gilt||5 years||Low||-0.04%||($40)|
|US Treasury Bill||90 days||Low||0.07%||$70|
|US Treasury Note||2 years||Low||0.14%||$140|
|Disney||5 years||A Rated||0.55%||$550|
|US Treasury Notes||5 years||Low||0.28%||$280|
|McDonalds||5 years||BAA Rated||0.59%||$590|
|Home Depot||5 Years||BBB Rated||0.64%||$640|
|Hilton||5 years||High Yield||4.78%||$4,780|
As you can see, low interest rates are a global problem and, as a result, investors across the world are taking on greater risk than they would normally to generate the income they need. Remember that even in this environment you should never violate a simple rule: investing entails taking risk – make certain you understand the risks you are taking and that you are paid adequately for taking those risks.