No doubt interest rates play an important role in the economy. They are a vital tool of monetary policy. Interest rates affect all of us but not necessarily in a good way. Let’s take a brief look at some of the pros and cons of a low interest rate environment.
Pros of low rates:
- Great borrowing costs to finance homes and cars.
- Great borrowing costs for business investments.
In general, credit is cheap. Low interest rates promote consumption that may not otherwise happen. It makes spending look like the right thing to do.
Cons of low rates:
- They hurt folks with fixed income assets like bonds and saving accounts.
- They do not reward fiscal responsibility, by businesses or individuals.
In general, money is too cheap. Low interest rates discourage savers. It makes saving look like the wrong thing to do.
Back in January, U.S. policy makers announced because of the underperforming economy, more “monetary accommodation” was required.
This implies interest rates will remain low until at least 2014. Two years is an eternity in the business world because so much can happen in that time span. Canada will likely fall in line, keeping rates low, since the U.S. has and will for the short-term, be our largest and most important trading partner. (China is however, catching up). I tend to disregard most economic proclamations by experts, because nobody, I mean nobody really knows when rates will actually climb nor by how much. If you know someone who can accurately predict the future, let me know 🙂
Assuming rates will stay low for some time, I’ve made some decisions about how to manage our debt and our investments. Here’s my 4-step recipe for the next couple of years:
- Continue to pay down our mortgage debt, more and more lump sum payments every year. This means increasing our lump sum payments over the next few years, money going directly on the mortgage principal.
- Avoid using our line of credit. We won’t touch it unless we absolutely have to.
- Continue to pay off all credit card transactions every month. This means avoiding purchases on our credit cards we cannot pay off in cash.
- Set aside 5% of our net income for investment purposes, namely in Canadian dividend paying stocks and low cost, broad-market ETFs. We will wait until savings accumulate and when we are comfortable with the stock or ETF price – we will make the purchase. Focusing on stocks specifically, we will work on diversifying our Canadian holdings with more stocks that have an established history of paying cash every quarter. Companies like TD Bank (TD), Royal Bank (RY) and Canadian Natural Resources (CNR) are a few stocks on my watch list.
I’m no financial guru but I see this prolonged low interest rate environment as a short-term blessing to solidify my financial plan. Pay down debt and make steady investment contributions. A simple two-step dance. In 2014 or whenever the interest rate alarm clock sounds, when inflation does eventually hit us harder that experts thought, we’ll be ready with less debt and more income-bearing investments.
This year, I’m going to be a maverick. I’m not going to borrow more like the low interest rate environment entices me to do. Instead, I’m going to do everything else but.