Do Higher Interest Rates Mean Better Return?

Many investors are frustrated with low interest rates, but the actual (real) return is not as bad as they think.

We’ve all heard the complaints. Interest rates are at historic lows, which frustrates many investors that want income, especially from low risk investments such as CD’s, money market funds or high grade bonds.

Interest rates on low risk investments have been near zero for several years now. Many investors are remembering the old days when government bonds and bank accounts paid much higher rates – sometimes in the double digits.

But was it really that different?

Actually, it wasn’t. Remember how high inflation was during the late 1970’s and early 1980’s. Basically the same time period when interest rates were high. What is important to investors is their return above inflation.

The numbers – back then

Here are two 10 year time periods. The first is a “high interest rate” environment, and the other is the more recent “low interest rate” environment.

10 years – January 1973 to December 1982

One Month US Treasury Bills   8.46%

Inflation                                              8.67%

Wow! so despite getting 8.46% return on short term government bonds – basically a risk free return – this investor still lost money after inflation. The real return was -0.20% to be exact.

And now?

10 years – January 2004 to December 2013

One Month US Treasury Bills    1.54%

Inflation                                               2.38%

The real return in this case is also negative at -0.81%.  It was a little worse than the earlier time period, but certainly not by as much as it would seem without adjusting for inflation.

Most importantly

The return on one-month treasury bills was negative in BOTH CASES after adjusting for inflation. This shows that a long term investor needs to take some investment risk in stocks just to keep pace with inflation, regardless of the interest rate environment.

Because Foster Wealth, Inc. helps inheritors with long, long term investment goals, we are highly aware of the negative impact inflation can have on the value of a portfolio. Over several decades, loss of value due to inflation is one of the greatest threats to a family’s wealth. We specialize in helping families find solutions to this challenge.