Saving for college is hard enough, but with a negative interest environment as discussed in a previous blog, it's REALLY hard...
Rates are negative on some Swiss government investments
Not likely an immediate concern for U.S. investors

COLLEGE SAVING IN SWITZERLAND

In Switzerland, the government recently sold 10-year government bonds at an ever so slightly negative rate of - 0.055%. What does that mean? Imagine a Swiss family trying to save for college for their eight-year-old child. Say they decided to invest 20,000 Swiss Francs in 10-year Swiss government bonds. At the end of 10 years they would get back roughly 19,890 Swiss Francs. About 100 less than they started with. If they had put it in their mattress, at least they would still have 20,000 Swiss Francs when Pierre-Yves turns 18.

Luckily there are many investment alternatives to 10-year Swiss bonds and this is one of the few situations where Swiss customers actually face negative interest rates. So far, the negative rates have generally been passed between banks and government institutions and the banks have simply absorbed the loss on negative interest as a "cost of doing business"

But if rates go further negative, things will get interesting. The banks may decide that at that point aggressive lending becomes preferable to the negative rates they are paying or they may pass the cost (i.e. the negative rates) on to business customers or even on to retail consumers and many more investments would yield "negative returns".

Certainly many investments can and do lose money over certain periods of time, but those are generally risky investments. The investments here are supposed to be "ultra safe" or even "guaranteed". Would you leave your money in the bank if the rate is negative? Would you buy a government bond with a negative rate?

Fortunately, in the United States, the Federal Reserve has indicated that they plan to slowly increase rates back to more historically normal levels. U.S. Markets have been quite volatile in late 2015 and early 2016 and there are many risks facing U.S. investors, but an immediate action to lower U.S. interest rates negative probably isn't one of them.

If you would like to discuss your College Saving strategy or the potential impact of negative interest rates in further detail, please schedule a free consultation.

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PLEASE REMEMBER:

- Investing and investment management involves risk, including the loss of your initial investment or any investment gains.

- Past performance is no guarantee of future results.

- This generic information is provided for educational purposes only and should not be construed as a recommendation for any individual to take a specific action.

- Please invest prudently and seek professional help from a financial advisor, investment manager, accountant, lawyer or other professional on matters that you are unsure of or that are unique to your personal circumstances.

- Financial Advisor and Investment Management Services provided by J. Bradford Investment Management, Nashua NH.

NEGATIVE INTEREST

• We are facing this situation because of the low interest rate environment that has persisted worldwide since the “Great Recession”

• Negative interest rates are as bad as they sound. Let’s say the interest rate is a negative one percent (-1%). I'm the bank and you give me $100. Then in one year, I give you back $99?!?

• The negative rates are primarily seen in borrowing and lending between governments and banks in Europe and Japan – consumers haven’t had much exposure to negative rates, yet.

Most of us recognize that we are in a “low interest rate environment” and have been since the Federal Reserve and Central Banks across the globe began lowering interest rates and taking steps to keep interest rates low in response to the Great Recession.

The practical impact to consumers of low interest rates has meant meager fractions of a percent of interest on our savings accounts, bank CDs and money market accounts and potentially no interest on our checking accounts.

GLOBAL IMPACT

The Great Recession had a global impact, so this low interest rate environment has generally persisted throughout much of the world for the last eight years.

Unfortunately, in many countries the economic expansion has been much slower and much less robust than anticipated and as a result, policy makers in many countries are continuing to look for ways to do three things:

1) Juice the engine of economic expansion

2) Strengthen currencies and

3) Fight deflation by inducing some inflation

All three objectives are generally accomplished by lowering interest rates. Generally, lower interest rates attract more borrowing for companies that would like to start or expand their businesses and when more companies borrow and expand – boom -- it creates jobs and economic expansion. That expansion should lead to rising prices and modest inflation and the low rates should strengthen the currency. The problem is that interest rates have been at or near zero for years and if governments now want to lower them further to pursue any of the objectives above, that means the rates have to be pushed negative.

In both Japan and Europe, some kind of negative interest rate environment similar to this is exactly what is happening. In many places the negatives rates only apply to banks and government borrowing and lending with each other, but it is happening. Because the rates are only ever so slightly negative right now, many banks are absorbing the losses associated with negative interest rates when dealing with retail customers and as a result, their profit margins are getting squeezed.

What happens if rates continue to go even further negative and the banks profit margins get squeezed too much? That remains to be seen because no one really knows for sure what the impact of significantly lower interest rates will be. Demand for the negative interest rate currency will likely rise and demand for hard assets like precious metals and real estate will also likely rise. But there will also be many unintended consequences and "shadow banking" type activities as consumers try and preserve the value of their money.

If you would like to discuss negative interest rates further or the impact on your portfolio, please feel free to schedule a free consultation.