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Returns Despite Low Interest Rates – How It’s Done

Forms of investments and strategies

How key interest rates influence investments

9 minute read

When the financial crisis hit the world economy nearly ten years ago, central banks lowered key interest rates worldwide in order to resist the crisis. Since then, interest rates are at a record low and make it difficult for investors and savers to make gains. How exactly do central banks’ monetary policies influence investments? And how can investors make profits despite minimal interest rates?


Key interest rates are set by a country or region’s central bank. The largest and most influential central banks in the world are the US central bank Federal Reserve (Fed), the European Central Bank (ECB), the Bank of England (BoE), and the Bank of Japan (BoJ). They determine key interest rates and deposit interest rates at regular intervals and thus influence first the bank sector, then the financial market, and ultimately a country’s entire economy.

The key interest rate determines the conditions in which a central bank deals with its associated commercial banks. It decides the interest rate at which the commercial bank can get money from the central bank. To put it simply, the key interest rate resembles the price of money. Money is expensive when the rate is high, whereas it’s cheap when the rate is low. The deposit interest, on the other hand, determines the conditions by which a commercial bank can “park” its deposits at the central bank. When the rate is high, then the deposits yield good interest. When the rate is low – or even negative, as it currently is in the Eurozone – then the incentives for commercial banks to store their deposits at the central bank become lower.

The key investment rate is the core element of monetary policy. The central bank uses it to try to influence the granting of credit in the economy. In the case of a high key interest rate, commercial banks grant loans only at high-interest rates. Lending is reduced, which means that the central bank can prevent the economy from overheating. With a low key interest rate, on the other hand, commercial banks grant loans at low-interest rates, which can boost lending and stimulate the economy.

Key interest rates have hit a record low. In the eurozone they are at 0.0%, in Japan 0.1%, in the USA 0.75%, and in Great Britain 0.5%. In Sweden (-0.5%) and Switzerland (-0.75%), the key interest rates are even negative. Denmark may soon be the third country that reduces its key interest rate into the negatives.


What impact do low-interest rates have on savers and investors worldwide?

Savers definitely suffer most under the low-interest rate policy. Banks hardly give any interest on deposits which makes it increasingly difficult for savers to make profits. The interest rates for call money are between 0-2%, depending on the bank – with a downward trend. Calculating the real yield of today's savings books, call money and fixed-term deposit accounts – i.e. comparing annual interest rates with fees and inflation – means that savings deposits achieve no or even a negative yield. This means that savings deposits on bank accounts lose value each year.

Added to this is the penalty interest, which some commercial banks are already charging on savings deposits. Because they themselves are punished with a negative deposit interest rate at the central bank if they "park" their deposits with the ECB overnight, the commercial banks are increasingly passing on these costs to their customers. They begin by charging large savings deposits with penalty interest and now extend these measures to ordinary call money accounts.

The first bank that introduced negative interest rates on call money was the Thüringer Skatbank. Customers with balances of more than 500,000 euro have to accept a negative return. According to a report in the Handelsblatt, the Raiffeisenbank Gmund am Tegernsee is also implementing a penalty interest of 0.4% on balances of more than 100,000 euro. This affects not only wealthy bank customers: since November, Volksbank Niederschlesien charges 0.6% penalty interest on each new call account, according to a Tagesspiegel report.

The only thing that is more damaging for savers is to store their money as cash at home. The Bundesbank states that around 550 billion euro are in circulation in cash. Germans hoard around a fifth of these (110 billion euro) in their homes according to Bundesbank experts. That is an average of about 1,300 euro per citizen.

Disregarding the risk of losing these savings in the event of theft, it loses its value annually without the influence of crime. Inflation is at fault for this, as it reduces a currency’s purchasing power over time. This means that even if those 1,300 euro are still lying under the saver’s mattress a year later, they will be worth less than they were a year earlier.


The low-interest rate policy is also a challenge for investors because it gets increasingly difficult to make profits through classic investments. The central banks’ interest rate policies determine returns on the capital markets. After all, key interest rates infer not only the interest rates of savings accounts; they also influence the returns of government bonds, insurance policies, and securities.

This means that yields on top-rated government bonds are very low. In some cases, investors have to pay for inflation-adjusted payments if they want to lend money to countries such as Germany or the USA over a long period of time. As a result, risk-free investments with low returns were turned into yield-free investments with low risks. Since conservative investments such as government bonds and fixed-term deposits are therefore hardly likely to generate income, there has been a shift towards riskier asset classes for years. In Germany alone, 3 billion euros were transferred from call money accounts to securities accounts in the last year.

The ultra-loose monetary policy of the central banks – in addition to maintaining low-interest rates, they buy shares and bonds worth billions every month – is driving stock market prices to ever new highs. Institutional investors like retirement funds, insurances, and investment funds increasingly invest in stocks and company shares because that is the only way for them to be able to fulfill their return promises to their customers. Life insurances are particularly affected, but so are savings and loan associations as well as pension funds.

Private investors are following suit because stock market positions have only known one direction for years, despite the weakening economy: upwards. If the central banks continue to pursue their ultra-loose monetary policy, share prices are unlikely to fall. On the contrary, there is a clear link between ultra-loose monetary policy and the all-time highs on the Dax and Dow Jones. And an old stock exchange saying advises to never to bet against the central banks.

Nonetheless, following this logic blindly can be dangerous for investors. After all, central banks starting with the Federal Reserve have already announced their departure from the low-interest rate policy. The Fed is increasing the key investment rate successively and is reducing its monthly bond purchases. This can result in faults on stock markets that have made themselves dependent on cheap money during the past ten years. Investors should be prepared for this with the right investment strategy.


The biggest challenge for private investors is the disturbed pricing on the stock markets, notes Daniel Steltner, former advisor to the Boston Consulting Group and currently a columnist at Wirtschaftswoche. A loose monetary policy has led to a distortion of prices for all assets (stocks, shares, and funds). The biggest central banks (ECB, BoJ, and Fed) collectively own around 20% of all government bonds.

Central banks have also invested in equities, equity funds and passive index funds (ETFs). The Japanese central bank now owns around 3 percent of the Nikkei and has invested almost 130 billion dollars in ETFs. For its part, the Swiss National Bank (SNB) has a strong presence on the US stock exchanges. It has bought technology stocks such as Apple, Facebook, and Microsoft for around 80 billion dollars. This drives the prices of these companies up.

What’s left for private investors? “Not buying anything because prices are manipulated is not a strategy. We have to accept that at the end of this game the authority of the central banks and confidence in the prevailing monetary system will be ruined. That's why money is probably the worst investment in the end,” states Seltner. He recommends a portfolio mix of one-quarter gold, stocks, real estate, and liquidity respectively. Cash reserves should be used for targeted purchases for market corrections.

The portfolio should be based on your investment personality. It is important to find out first whether you tend toward security or risk. Subsequently, the portfolio should be sufficiently diversified. Part of the assets should be invested in secure assets that ideally generate a regular cash flow.

Fixed-interest securities, i.e. corporate bonds of large corporations as well as government bonds, can serve as secure assets with low-interest rates. Real estate is also a safe form of investment, especially if it generates a regular rent. Precious metals, especially gold, are suitable to store value. In times of minimal interest rates, however, these investments will only allow you to maintain your assets or even achieve a slightly negative return in times of minimal interest rates.

In order to obtain a "green branch" nevertheless, there is no way around profit-oriented assets. Initially, shares of established companies are suitable for this purpose. Ideally, they generate a regular return of capital via a dividend. In addition, equity funds and exchange-traded index funds (ETFs) can be a useful addition to the portfolio. ETFs are convincing due to their low costs and solid performance, as they usually only represent one index, e. g. the German benchmark index Dax. If the Dax rises in the long term, investors will also benefit.

Finally, a small portion of the available assets should be invested in high-risk assets with a particularly high return potential. These include equities and equity funds with European and non-European standard values, speculative real estate funds, high-yield bonds for less established companies and off-market venture capital. The latter also includes equity crowdfunding, in which private investors with venture capital participate in startups in order to profit from the sale proceeds in the event of an exit.


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Status as of 04.10.2017 18:47


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André Jasch

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