Sep 24, 2020
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What Are ‘Negative’ Interest Rates And How Can You Make Money From Them?

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Imagine going to the bank loan officer and being told they d pay you in case you took out a loan with them. That s how negative rates of interest work. It sounds silly. It s counterintuitive. It s occurring in Europe right now. But not in America. Causing some confusion the sudden talk of negative rates of interest coincided with a unprecedented event during our current inverted yield curve climate

It’s true an inverted yield curve often anticipates an economic downturn

 

There’s however some debate whether today s inverted yield curve is predicting a recession. There s some thing you are going to be sure of though. An inverted yield curve isn’t the same as negative interest rates. An inverted yield curve merely means shorter term maturity fixed income instruments are paying a much better rate of interest than long term maturity fixed income instruments

This usually but not always occurs because investors feel a slowing business cycle means their equities won t experience the expansion rates they re targeting

 

Negative rates of interest represent an entire nother kettle of fish. Comparing them to an inverted yield curve is like comparing apples and oranges. Correctly it s possible to experience negative rates of interest with no need an inverted yield curve

To explain the operational definition of negative rates of interest examine a standard fixed income transaction

 

Ordinarily when you buy a bond the issuer pays you interest in exchange for the rights to use your money for a period of time says Ric Edelman co-founder of Edelman Financial Engines. But when rates fall below zero you re actually paying the issuer to hold your cash for you

Investors are willing to pay this fee only once they feel that the other choice is riskier

 

going to buy a car

The dealer promises two options to pay for the recent vehicle: cash or credit. When rates are above zero buying a car on credit will cost you more because you’ll have to pay interest on the loan. When rates of interest are negative it’ll be cheaper to buy the car on credit than with cash! That s not the sole owing to earn money with negative interest rates

Astute investors can find uncommon opportunities in such situations

 

The apparent case is the same advantage all bond holders experience during times of falling interest rates. Those who already own bonds will benefit says Edelman because currently existing bonds rise in value when rates of interest decline. Should a negative rate of interest scenario arise borrowers have the advantage over lenders

Negative rates of interest will clearly hurt industries companies and institutions that have faith in loaning money

 

But maybe not all of them. The negative portion of negative rates of interest won’t hold among all bond classifications. It may be that traditional high-yield bond markets the riskier portion of the fixed income spectrum will remain in positive territory

These might therefore represent the lending market lenders will pursue

 

Other lenders might choose to avoid the prospect and continue to provide loans with negative interest rates. This presents an awesome opportunity for people and organizations seeking capital to expand revenue generating operations. It s greater than free money. You re actually getting paid to borrow money

In case you re saving for retirement you ll desire to put money into stocks that could transform that no-cost capital into more profits

 

On the personal side you could find it more lucrative to restructure all of your loans into negative rate of interest loans then defer any repayment until the due date

Are you ready to say goodbye student loan crisis ? Contained in the meantime your cashflow balloons (since you not have loan payments to make)

 

Who knows maybe you could now buy those stuff you have been pushing aside purchasing. And in case you re increasing your purchasing everyone seems to be increasing their purchasing

And if everyone seems to be buying where do you think their money is going? Into the companies making those goods

 

These companies will likely see appreciation of their stock price and will they pay them an increase of their dividends. And dividends would be the key factor for retirees

Those who’ve already retired and who’ve trusted fixed income investing to provide a gentle flow of money will quickly learn the meaning of rate of interest risk when their bonds mature during a time of negative interest rates

 

Rate of interest risk alludes to the lack to reinvest your principal in a fashion that yields the same fixed return

Dividend paying stocks will for that reason represent a more attractive alternative. This demand can then further push up the price of dividend paying stocks. Now despite all this good news don t go cheering for negative interest rates

 

First they could bring forth unpleasant and unexpected side effects

Second things need to get pretty bad from an economic perspective to justify negative interest rates. And no-one wants to go there. So in case you re retired or saving for retirement what do you have to be more worried about: negative rates of interest or a trade war with China? Neither says Edelman

Retirees ought to be worried about with the ability to generate the income they want for the remainder of their lives

 

Negative rates of interest and the trade war are both short-term issues which will be soon resolved and thus quickly forgotten

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