Over the last 40 years interest rates in the U.S. have fallen dramatically. With each successive decline, it’s been tempting to think “this is it, now interest rates will finally begin to rise again,” but that has yet to happen. In fact, although the interest rate on the benchmark 10-year U.S. Treasury bond has risen slightly since its low of 0.9% at the end of 2020, it is still well below historical averages.
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In this article, we explore the impacts and opportunities of a low interest rate environment for saving, investing, borrowing, and estate planning.
The most apparent and direct impact of a low-interest environment has been on savers. Long ago, those who socked away money in a bank savings deposit account could rely on the interest earned on those funds to cover routine expenses and build wealth. In recent years, most savings accounts have yielded close to 0% interest. When you consider the erosive effect of inflation, the buying power of those savings has actually decreased over time.
By the same token, the role of fixed income in investors’ portfolios has come into question. Research from Callan suggests that in 1989, investors could achieve a 7.5% return from a portfolio allocated exclusively to fixed income and cash. U.S. government bills, notes, and bonds, also known as Treasuries, have long been considered the safest investments in the world. With less volatility than stocks, fixed income has been used for decades not only to add valuable diversification to a portfolio, but also provide investors with a steady stream of income. But at today’s interest rates, the “safe” choice looks a lot riskier in terms of meeting your income needs.
Although low interest rates make it more difficult to generate income from cash and fixed income, the solution isn’t simply to take on more risk by investing in securities with the potential for higher yields. Instead, investors need to think more creatively about how to generate income, and carefully balance the tradeoffs between risk and return potential.
We also understand that interest rates won’t always decline, so additional preparation is required for when that scenario happens.
Opportunities For Low-Cost Credit
For investors who need liquidity, collateralized lending may offer a cost-effective financing alternative in a low interest rate environment. Also called margin lending, the idea is that instead of selling any of your taxable investments, and possibly paying capital gains taxes, you borrow against these assets from your custodian (e.g., Schwab, Fidelity). They lend you cash at a rate of interest that is usually variable, and generally very low -- often lower than home equity lines of credit (HELOCs) or standard bank lending rates. Using your assets as collateral to create your own lending source can help you address short-term cash needs, refinance higher interest debt, or invest in higher-yielding assets, while allowing your existing portfolio securities to continue growing. In some cases, the loan can be structured so that the interest is tax deductible. However, this strategy isn’t right for every situation, so you should carefully consider all the risks and benefits of margin borrowing.
Because interest rates are used to determine the value of remainder interest in a trust, low interest rates generally favor certain estate planning strategies over others. For those with sizable estates, a zeroed-out Grantor Retained Annuity Trust (GRAT) may be a valuable tool particularly when interest rates are low. The tool allows the giver of the gift (grantor) to fund an irrevocable trust, which pays the grantor a predetermined annuity over a set period. If, over that term, the trust assets outperform the annuity interest rate (called 7520 rate), the growth or “remainder interest” of the gift is transferred free of estate and gift tax. In short, GRATs can remove appreciation on the transferred assets from the grantor’s estate, at minimal or no gift tax cost. In combination with professional investment management, a GRAT offers wealthy individuals and families the ability to gift assets in excess of the annual gift exclusion, while preserving their lifetime exemption. Learn more about GRATs here.
These are just a few strategies that might be advantageous in a low interest rate environment. However, the right strategy for you will depend on a variety of factors, so it’s always a good idea to speak with a professional financial advisor about your unique situation and needs. Also, keep in mind that interest rates won’t be low forever. For that reason, any strategy you choose should be flexible enough to account for the possibility of higher rates in the future.
Article By Grant Ruder, CFP® and Chris Maxey, CAIA
About the Authors
Wealthspire Advisors is an independent RIA providing comprehensive financial planning and investing services to retirees, multigenerational families, and high earners with complex tax, estate, and charitable planning needs.
Chris Maxey, CAIA, Senior Vice President, focuses on portfolio construction, asset allocation, money manager research, and due diligence. As part of the firm’s Investment Committee, Chris provides ongoing guidance and expertise in capital markets to wealth advisors.
Grant Ruder, CFP®, Managing Director, integrates expertise in investment management, cash flow, retirement planning, insurance, estate, and tax planning. He serves high net worth individuals and their families, endowments, and other institutional clientele.