Interest rates have dropped so low that savings accounts pay just above zero. Could those rates fall to below zero? In many countries, they have.
Negative interest rates are a new risk to savers. There are actions you can take, but first let me explain what negative interest rates mean.
In Switzerland, if you put 10,000 Swiss francs in a one-year account at a bank, you will be paid an interest rate of minus 0.678%. That means that at the end of one year, you will get back 9,932 francs. Other countries where some rates are negative include Japan, Austria, France, Ireland, Sweden and Italy.
Back in the U.S., our Federal Reserve has held its overnight interest rate near zero for seven years. Now the Fed says it may raise that rate this month because the economy has healed from the 2008 financial crisis. Higher rates now could weaken the economy and lead to rate cuts later that could put us in negative territory.
One step you can take is to put part of your savings into 10-year Treasury securities. Just because you are buying a 10-year Treasury doesn’t mean you have to keep it for 10 years. You can sell it before maturity at its market price, which will fluctuate.
Currently, the U.S. 10-year Treasury note is yielding about two percent. That seems low but is high compared to Germany’s 10-year government bond at 0.47 percent, Japan’s at 0.29 percent, France’s at 0.79 percent and Switzerland’s at minus 0.4 percent (according to Bloomberg Business website).
Here are two ways to invest in 10-year U.S. Treasuries, and how they might work out:
n 10-year U.S. Treasury note: You can buy the two percent Treasury that matures August, 15, 2025, for about $1,000. The U.S. Treasury promises to pay you $20 a year interest, and $1,000 principal at maturity on Aug.15, 2025. The interest is subject to federal tax but exempt from state tax.
If you want to sell before maturity, the price will fluctuate. In August, 2016, with nine years to go till maturity, if the current rate on Treasury notes of similar maturities has fallen from two percent to one percent, you would be able to sell your Treasury note for about $1,085. That would be a gain of eight and a half percent, plus the two percent annually in interest would give you a double-digit total return.
If, instead, interest rates rise and you want to sell, you would take a loss. If in August, 2016, comparable Treasury rates have risen from two percent to three percent, you could only get about $921 for your Treasury note. If you hold on to the maturity date in 2025, you are guaranteed to get back your $1,000 plus $20 a year in interest.
n 10–year U.S. Treasury Strips (also known as zero coupon Treasuries.): For tax reasons, these fit best in tax-deferred accounts like IRAs. Currently, you can buy Strips maturing November 15, 2025, for about $800 per thousand. They make no annual interest payments but mature at $1,000 on Nov. 15, 2025, giving them a yield to maturity of 2.26 percent.
If, in August 2016, comparable rates have fallen to one percent, you could sell your Strip for about $911, a gain of 13.9 percent. If rates have risen to three percent, you could only get $759 for your Strip. But if you hold on until November 15, 2026, you’ll get $1,000 at maturity.
You can buy these through the U.S. Treasury at www.treasurydirect.gov and pay no commission to buy, but you can’t sell before maturity through Treasury Direct. To do that, you’d need to deal with a broker and pay a commission, which should be small for Treasury transactions, as long as you’re dealing in minimums of $20,000 for notes and $5,000 for Strips.
Mark Rosenberg is a financial adviser with Financial West Group in Scotts Valley, a member of FINRA and SIPC. He can be reached at 439-9910 or [email protected].
