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The Low Rate Problem

Investment

ON THE WEALTH MANAGEMENT IMPLICATIONS OF HISTORICALLY LOW INTEREST RATES

Though interest rates have been falling for 40 years, it was only within the last decade that central banks took things to the extreme, setting rates near (or below) zero in order to stimulate economic activity. This has had ramifications across financial markets, and just as there was a dash of optimism rates may move higher, the coronavirus pandemic struck. Due to the long-term economic damage of the pandemic (and continuing the multi-decade trend of falling interest rates), one could reasonably assume low rates are here to stay for a bit. So let’s quickly run through some implications:

1. Lower returns on bonds – The best predictor of long-term bond returns is the starting yield, and current yields are historically low. This ups the difficulty level for investors, but accepting this and preparing your financial plan accordingly is key. Higher quality corporate debt may offer opportunity.

2. Don’t reach for yield – Low rates are brutal for savers and retirees, but reaching for yield in riskier and more dangerous investments can have devastating downside. Even relatively common asset classes are susceptible: Nearly 60 S&P companies have cut/suspended their dividend this year, while the default rate on high yield bonds is projected to skyrocket into the double digits.

3. Smart debt is more attractive – The 30-yr mortgage rate fell below 3.00% for the first time in nearly fifty years. Low rates are a challenge for investors, but there are also opportunities to capitalize on this phenomenon (e.g. refinancing).

4. Persistently higher valuation multiples – Credit Suisse recently concluded that lower yields justify (or at least partially explain) higher multiples (e.g. P/E ratio) on equities. Essentially, stocks look more expensive than they have historically, but this makes sense with bonds less attractive. Gold could see a boost from this dynamic, too.

5. Control what you can – If we can reasonably conclude that we’re entering a lower return environment, then controlling the little things in our power makes even more sense. Namely, costs, savings rate, and tax planning. Every dollar optimized on these fronts is an extra dollar working toward your long-term goals, regardless of return. Low rates are a challenge, but solving problems like these are what your Baird Advisor is here for. All of these topics, from tax optimization to investment strategy, are areas where expert guidance is key for long-term success.


Disclosures

This is not a complete analysis of every material fact regarding any company, industry or security. The opinions expressed here reflect our judgment at this date and are subject to change. The information has been obtained from sources we consider to be reliable, but we cannot guarantee the accuracy. This report does not provide recipients with information or advice that is sufficient on which to base an investment decision. This report does not take into account the specific investment objectives, financial situation, or need of any particular client and may not be suitable for all types of investors. Recipients should consider the contents of this report as a single factor in making an investment decision. Additional fundamental and other analyses would be required to make an investment decision about any individual security identified in this report. For investment advice specific to your situation, or for additional information, please contact your Baird Financial Advisor and/or your tax or legal advisor. Fixed income yield and equity multiples do not correlate and while they can be used as a general comparison, the investments carry material differences in how they are structured and how they are valued. Both carry unique risks that the other may not. Past performance is not indicative of future results and diversification does not ensure a profit or protect against loss. All investments carry some level of risk, including loss of principal. An investment cannot be made directly in an index. Copyright 2020 Robert W. Baird & Co. Incorporated.