What to expect in low interest environment and how to manage risk.

 

We are inevitably heading towards a low-interest environment. There are opportunities as well as certain risks in a low-interest environment. The ability to borrow at lower rates will increase money circulation and spur economic activities. Investors will look at alternative investments as interest earnings from their investments start to fall. If you know the characteristics of the low-interest rate environment you can manage the risk while earning high returns from the investments. The investment portfolio should be adjusted regularly according to the market conditions to grow the portfolio.

 If you know how to play smart you can steer through the low-interest environment by maximizing the returns. Here are some key points to consider before you invest or borrow in a low-interest environment.

·        Mushrooming of pyramid schemes.
·        There is a high tendency to obtain loans for consumption by individuals.
·        The revenue of companies will improve.
·        Banks will focus more on fee income-generating activities.
·        The low spending power of senior citizens.
·        Investors shift money from fixed income to stocks.
·        People will invest more in real assets.

 

Mushrooming of pyramid schemes.

People who get used to receiving high-interest income from their fixed-income investments will be encouraged to take excessive risks in a low-interest environment. Scammers might introduce bogus investment plans and pyramid schemes targeting vulnerable investors who look for high returns. People with low financial literacy and investors who only look at high returns can be the victims of such schemes in low-interest environments. Returns correlate with risk. Do not forget that high return comes with a high risk.

 

There is a high tendency to obtain loans for consumption by individuals.

When borrowing cost is low, people will borrow more for consumption or to upgrade their living standards. This will reduce the disposable income of the borrowers. As per the interest rate cycle, interest rate fluctuates over time as market interest rates change. When interest rates shift from a low to high-interest rates environment, lending rates will start to rise. Repricing of lending rates will further reduce the disposable income of people who have borrowed more for consumption.  This can hurt the ability to spend.  

The revenue of companies will improve.

Companies are borrowing money to fund their day-to-day operations. Interest cost represents the higher portion of their total operation cost. When interest rates fall, it becomes more cheaper for companies to borrow. Lowering cost will improve their income margins and fuels the growth. As consumers borrow more at lower rates and spend more for consumption can expect revenue growth. As a result, companies will have high profits which will move the stock price up.

 

Banks will focus more on fee income-generating activities.

As margins become thinner interest generating activities will no longer give desired profits for banks. Banks will have to look for more fee-generating activities to bridge the gap. The funding mix will change by reducing short-term borrowings and mobilizing more deposits to fund themselves. An increase in loan portfolio with high-quality assets will reduce the NPL ratio. If banks can generate more fee income and grow quality asset portfolios in a low-interest rate environment, they can improve their profit margins.

 

The low spending power of senior citizens.

Senior citizens are highly dependent on interest income and lowering their monthly interest income will reduce their spending power. Senior citizens might get attracted to risky investments that offer high returns. The larger portion of their expenses is for medicines. Due to a reduction in interest income, they might shift from high-quality drugs to low-quality drugs, which are available at a lower price. Seniors depend on fixed-income instruments for stability and income. They have limited options to invest and might not consider options like unit trusts, equity investments, or investing in commodities which expose them to more risk. Building up a long-term investment portfolio in a low-interest environment may not be practical as returns of the investments might not cover the expenses over time.

 

Investors shift money from fixed income to stocks.

Bonds and interest rates have an inverse relationship. Whereas interest rates fall, bond prices rise. In a low-interest environment share market performs better as many investors reduce the allocation to fixed-income instruments and invest in stocks to get high returns. This will intern make the share market more active and likely to generate high returns on stocks. If your portfolio has high exposure to stocks, it might put your portfolio over the risk level. It is important to know that having fixed-income instruments in the portfolio gives portfolio stability and it is always better to have a balance in the portfolio.

 

People will invest more in real assets.

When mortgage loan interest rates fall, people will start borrowing and investing in lands and properties. Lands and property prices will move up due to high demand. This is a good opportunity for investors to invest in land and properties before prices move up. Real assets are not only lands and properties, they include other tangible assets such as commodities, precious metals, equipment, natural resources, etc. You can diversify your portfolio by investing in real assets and hedging against inflation. Real assets have the potential to produce an additional income as well.

 

Conclusion

A risk-averse investor may allocate more to fixed-income instruments to maintain a stable portfolio. Investors with a high-risk appetite may increase exposure to risky assets to gain high returns.

Borrowing and investing in real assets is a risky proposition. Knowledgeable investors can borrow at low rates and invest in high-yielding assets.

It is important to assess your risk tolerance level, expected return, ability to take losses, and current and future market conditions before making the investment decision. Some strategies can help you to maximize returns while mitigating risk in any market condition. Knowing the right strategy will help you to play smart in a low-interest environment.