Low and Negative Interest Rates seems to have become our permanent environment. Why did this happen? And what does this mean for investors?
Low interest means what you think – it may be less expensive to finance large purchases like a car or home, but it can also mean lower returns on certain types of investments like bonds, CDs and more. But how can an investor earn higher income when this occurs? Alternatives might be one of the best... well, alternatives.
Let’s step back a moment and talk about the role of central banks and the interest rate at your local bank. Most countries have a central bank. In the US, it’s called the Federal Reserve Bank or the Fed. These central banks loan money to local banks at a Federal Funds rate; the local banks then turn around and loan it to consumers at a higher rate – thereby making money on the difference or spread. So, for instance, if the Federal Funds rate is 0.05% and your bank lends you money at 3.75% on a 30-year loan, the local bank is making money on the almost 4% difference over 30 years’ time.
For the first time since 2008, we have seen not one, not two, but four interest rate cuts from the Fed this year. Central banks lower their interest rates to stimulate the economy by incentivizing investors to seek out investments that they hope will grow at a higher rate than cash. As a result, the market usually rallies after a rate cut. In a sense, the Fed is saying, “Don’t just let your money sit there, do something with it!”
How low can interest rates go? Lower than you might think. There are central banks in Europe and Asia that have lowered their interest rates below zero. Simply put, holding cash in an account with a negative interest rate means you will take out less than you put in; for the risk- averse, it’s a safe way to hold cash without losing too much value. But it doesn’t bring you income.
What can investors do to earn higher income? Since the Jumpstart Our Business Startups (JOBS) Act of 2012 was signed into law by President Obama, the world of alternative investments, specifically investing in private funds, has been more accessible for the average investor. Alternative investments include real estate, hedge funds, private equity, commodities, marketplace lending and precious metals. Once perceived to be only available to institutional and ultra-high-net-worth investors, an increase in technology-enabled platforms and investor awareness has allowed for these asset classes to grow and become more mainstream.
One of the differentiating features of alternative investments is that they are not “marked to market,” meaning that they don’t go up and down in value based on the stock market. They are not valued daily like investments in the public markets of the NASDAQ or the NYSE. It doesn’t mean they won’t change in value, but they aren’t likely to be as volatile as stocks can be based on the latest news report.
Let’s talk a little bit about one such alternative investment class—private debt—and how these investments might perform favorably from simply letting your money sit.
Since interest rates are low, banks are less interested in issuing short-term loans. After all, they make their money on the spread—or the difference in interest rates over time. Short-term loans don’t offer enough time for them to earn significant interest. So, what can small businesses and individual investors do when they need capital right away? They can invest in non-bank portfolio lenders in the marketplace.
Let’s take an example of non-bank portfolio lending in private debt, real estate bridge loans.
A bridge loan is a short-term loan used until a borrower secures permanent financing. It allows the borrower to quickly purchase a property when traditional financing from banks can take three months or longer. Bridge loans are often used for the acquisition of apartment buildings and other multifamily property types, and then a period of rehab or repositioning of properties that do not operate at stabilized levels, in order to be eligible for permanent financing. Bridge loans are short term, up to one year, have relatively high interest rates, and are fully backed by real estate.
Investors in the non-bank portfolio lender’s fund earn an interest rate much higher than the market. To keep risk low, investors can choose a fund that lends on income producing commercial real estate, especially multifamily apartments.
Interested in learning more about alternatives? We created the Millennium Alternative Investment Network® to help advisors and investors:
DISCOVER the basics of alternative investing and how they can be part of your retirement portfolio.
RESEARCH the various alternative asset classes and investment platforms.
INVEST through one or more of the ever-expanding number of investment platforms.
To learn more visit mtrustcompany.com/main.