A few years ago, if I had suggested that it would be sensible to consider how negative interest rates might affect your retirement, you would have probably said: “don’t worry, that’ll never happen”.
But now, negative interest rates have been in place for some time in several, developed economies, and the UK could be next.
The Eurozone interest rate has been negative since 2014 and was recently reduced to -0.5%, while in Switzerland, the bank base rate is -0.75%, and in Japan, it is -0.1%.
How are Savers Affected by Negative Rates?
Negative interest rates don’t necessarily result in savers having to pay the bank to keep their money for them. We still have paper money, so we still have the option to withdraw balances and store savings in physical form— “putting our cash under the mattress”.
In Switzerland, banks have not passed the negative base rate on to consumers—the average interest rate on savings accounts (typically used by households) is still around 0.1% (not much different from many of the UK’s high street banks!).
However, many Swiss banks have passed on negative rates to business customers (as businesses can’t put their cash under the mattress) and a handful of Swiss banks have recently announced that they may start charging their wealthiest clients to hold large deposits later this year.
Businesses are having to pay banks around 0.5% per year in interest on deposits.
Fixed Income Investments
It’s not just deposit rates which can be negative. The rate of interest payable on fixed interest stock (loans to governments and companies). So, it would be possible for yields on gilts and corporate bonds to turn negative. Around the world, there is $15,500,000,000,000 of fixed interest stock, which has a negative yield.
That means that there is a huge number of investors who are prepared to pay money to governments and companies for being allowed to lend them money!
The UK government hasn’t quite managed to persuade investors to pay them to allow it to borrow money from them, but the yield on the most recent 5 year gilt was only 0.225% at launch.
The only significant countries whose governments have no negative-yielding debt are the UK, USA and Italy.
How do Negative Interest Rates Affect Investments?
The honest answer is that we don’t know.
The concept of debt can be traced back to the Sumerians in 3,000 BC, and for almost all of that time, borrowers have had to pay interest to lenders.
Negative interest rates only have a history of about ten years, so we don’t know how they will impact investments.
In a world of negative interest rates, we know that if you take no risk, you will lose money in nominal terms. But you will only lose money in real terms if inflation remains positive too.
UK inflation continues to be positive, and the recent weakening in Sterling makes deflation unlikely. So, it’s likely negative real returns for low-risk investments will continue to be the norm.
The anticipated return for risk-free assets does tend to set a benchmark for riskier investments, so, in a world of negative interest rates, we might expect lower long term returns from investments like shares, property and high yield bonds.
However, in the short-term, if investors move away from cash to higher risk assets, the price of shares etc. could rise.
Negative interest rates will likely increase the amount by which asset prices fluctuate – the market hasn’t had to deal with negative rates before and is likely to become increasingly nervous.
What Does It All Mean for Retirement?
The main reason that we have negative interest rates is that central banks want to avoid their country becoming the next Japan, where prices fell from 1999 to 2012.
Our studies show that retirees, who are relying on investments to pay a large proportion of their income, are affected most severely when the inflation rate is a lot higher than investment returns.
If central banks are continuing to fight deflation with negative interest rates, then the price of the things you are buying will be going down. In a deflationary world, a return of 0% means that the spending power of your retirement funds has gone up.
So, if general investment returns continue to exceed inflation (or are less negative than deflation), the impact is unlikely to be substantial.
The increase in volatility is likely to have an impact, and retirees need to have plans in place to cope with this.
Don’t Worry About Things What you Can’t Control
You can’t control interest rate policy, and you can’t control how markets react to it. Studies have shown that a good retirement plan will enable you to cope with anything the markets can throw at you.
Stick to your plan and enjoy your retirement years!
