7 places to invest when interest rates are low

With an uncertain New Zealand economy and the Reserve Bank’s official cash rate set to an all-time low, Kiwis with money in the bank are struggling to find a decent return. So how can you adjust your investment plan to make the most of a falling interest rate environment?

The good news is that many investment options can perform better when interest rates go down or when the economy is under performing. You have the potential to get larger returns than you would from your bank — you just need to be willing to take on a higher level of risk and do your homework. Here are seven options to consider.

Stocks

Low interest rates may be good news for growth assets such as stocks, as interest payments are often a major cost for businesses. In other words, lower rates may mean increased profits for businesses, resulting in potentially rising share prices.

Though picking the right shares to buy and sell is easier said than done. If you want shares that can provide capital growth, you may need to look beyond the large-cap stocks on the market. Shares can also provide an ongoing source of income through dividends, so you also have the option of investing in companies with a history of paying solid dividends to shareholders.

Remember that share prices fluctuate all the time and there’s no guarantee that a company will pay dividends.

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ETFs and index funds

Investment funds that are listed on the stock market, known as exchange traded funds (ETFs), provide investors with the opportunity to buy and sell units in these funds in the same way they trade shares. Each ETF contains a portfolio of assets — shares, commodities and bonds, for example — and many are designed to track a specific market index called index funds.

ETFs offer an uncomplicated way to invest in specific markets, industries or commodities. For example, if you think gold prices are due to increase, you can invest in an ETF that tracks the price of gold. If you’ve got a feeling that the New Zealand market is set to boom, invest in an ETF that tracks the NZX 50. Not all ETFs are passive index funds. Some are riskier than others.

Peer-to-peer lending

Peer-to-peer (P2P) lending funds offer an alternative investment opportunity, often with competitive returns. When you invest in P2P lending, you’re essentially playing the role of a bank. In other words, you lend your money to one or several borrowers through a third-party lending website, which you’re then paid back at an agreed-upon rate of interest within a set time frame.

As the lender, you get to choose how much money you wish to lend and at what interest rate. The lending platform then matches you up with borrowers in need of funds. These types of loans are usually offered as car loans, business loans, personal loans or for debt consolidation.

Not all P2Ps offer the same level of security. While some advertise interest rates upwards of 20%, you may also risk losing your investment if the borrower defaults on the loan.

Property

When interest rates are lower, owning property should become cheaper and more attractive. An investment property can provide ongoing income through rent payments and capital growth as housing prices rise. Before investing, always know the risks involved, such as buying at the wrong time, dealing with problem tenants and coping with market downturns.

Other options are real estate investment trusts (REITs) and property stocks. These can give individual investors access to property assets that may otherwise be beyond their reach, such as large commercial properties, apartment buildings and hotels.

REITs are a way to diversify your portfolio and could also provide an income stream in the form of monthly or quarterly dividends.

Corporate and government bonds

The bond market usually performs better when interest rates drop and the stock market becomes more volatile. This is because bonds are considered to be one of the most secure investment options available in the market.

When you invest in bonds, you’re lending money to the government or a company for a set period of time, similar to a term deposit. In return, the organisation pays you back at a fixed rate for the length of the term. While you can’t usually expect the same high returns by investing in bonds as you might get from stocks and shares, government bonds are typically classified as the safest — while corporate bonds vary depending on their credit ratings.

Historically, you needed large sums of money to invest directly in bonds. But in more recent years, it’s become possible to invest in bonds through the stock exchange with a few hundred dollars in products such as bond ETFs and exchange traded bonds.

Gold

When interest rates fall, it’s usually a sign from the Reserve Bank that the economy is underperforming — which may indicate an upcoming boon for the gold market.

This is because gold is regarded as a stable investment that’s less volatile than regular stock or forex markets, so people often turn to the precious metal as a way to protect their wealth. Although not truly inverse, it means that gold prices typically go up in a falling cash rate environment.

To invest, you can buy physical gold from a bullion dealer, invest in gold stocks or invest in a gold fund such as an ETF.

Infrastructure and utilities

When interest rates are low, seasoned investors commonly shift more funds into real assets, such as property and utilities stocks. At the same time, it pays to be cautious of financial stocks — since profit margins among lenders drop when rates are low — as well as the riskier growth stocks.

Ports, rail, airports, toll roads, utilities, telecommunications, schools and hospitals are always in need, no matter the level of interest rates. So investing in infrastructure provides the potential for solid returns — plus, it allows you to diversify your portfolio.

How do low rates impact investment markets?

While there’s always debate about what impact an interest rate decision will have on the economy, certain situations may apply:

• Stock market rises. Shares become more lucrative investments as bank products see returns dwindle and consumer spending increases.
• US dollar falls. Lower rates usually pull down on local currency as foreign investment becomes less attractive.
• Bond market may rally. When interest rates fall, bond prices may rise and vice versa.
• The export sector wins. A lower dollar makes US goods more competitive on global markets. Conversely, the imports sector will find it harder to make profits.
• Domestic spending increases. Lower rates should encourage households to save less and spend more, however, this could be tempered by flat wages.
• Dividend stocks may become more attractive. As capital returns become harder to achieve, dividend paying stocks may become more popular.
• Bank stocks might fall. Low rate environments can make it a challenge for banks to maintain profit margins.
• Real asset stocks may rise. Real assets such as property and utilities stocks may become more attractive for investors.

Tips for investing when interest rates are low

There’s plenty more you can do to improve your financial position and maximize investment returns in a low interest rate environment. Make sure to:

• Pay off your debt. When interest rates are low, try paying off as much existing debt as possible. For instance, you could make extra mortgage repayments and increase the equity in your property, which can act as a safety net against future rate rises.
• Diversify your investments. Don’t put all your eggs in one basket. Spread the money around so if a specific industry or asset class takes a dive, your entire portfolio doesn’t go down with it.
• Know how much risk you can tolerate. Any investment other than a conventional bank deposit attracts a higher level of risk. Make sure you know how much risk you’re willing to take on before you invest anywhere.
• Maximize your savings. If you have money in a savings account, review your account regularly when rates drop and shop around for the best savings interest rate available.
• Stay flexible. Interest rates are probably going to increase again at some point in the future, so make sure you understand the implications of locking your funds away in a long-term investment such as a five-year term deposit or bond.
• Understand your investments. Don’t simply follow the crowd. Understand an investment before putting any money toward it. If you don’t know what you’re getting yourself into, that’s a surefire recipe for disaster. Seek professional advice whenever necessary.

Bottom line

In an economic climate where the official federal cash rate is heading toward zero, you could still make your money work harder for you by choosing specific investment strategies. No investment is guaranteed, and if you’re new to the world of investing, be sure to educate yourself before moving forward.