Low Interest….Bubbles…Distortions and Excess Risk Taking

Interest rates can have an impact on investing.  Below are 3 point key points to watch during times of very low interest rates.

1. Cheap Credit

With interest rates at historical lows, it is very easy for people to think this is the “new” long-term norm.  Currently, home loan interest rates are sitting at levels around 4-5% and this can entice big eyed and envious home owners to bite off a little too much than they should really hold in debt levels.  

The previous sub prime melt down is one recent example to what might happen to a borrower if one day the interest rates should rise back to more normal levels.  

So be cautious not to over indulge in too much credit, as it has had a habit of coming back to bite you!

2. Bubbles and Distortions

Low interest rates can often cause distortions in the market place.  Often when people who “have” money to invest but can’t find an appropriate return on their capital in cash or term deposits/bonds, they are then forced too seek out alternative options.

It is important to understand where this money will flow to and which asset classes.  Bubbles are not all bad….they provide the opportunity to make a tremendous amount of money – it is just knowing the right time to get off the  high speed fast train. Whilst this can seem like a crazy thing to do… it is only when you see the train launch off the cliff, that you breath a sigh of relief that you made the jump before things started to get really scary.

Allan Greenspan’s low interest policy in the early 2000 is often cited as one of the causes which may have been responsible for the US housing bubble.  

It is important to acknowledge that understanding that the market may not be normal and can provide sometimes irrational behaviours.  Be careful not to think this is the new “status quo” when returns start to really crank up.  Be careful not to start extrapolating this performance into the future indefinitely.

3. Excess Risk Taking

Investors are renowned for doubling down on a sure beat.  When something performs well it is often hard to resist the call to double up the exposure to try and magnify the result.  When we see cheap credit and distortions in particular markets, it is important to not get too carried away with excess risk taking.

Ensure to poke yourself regularly to see if you are becoming overly concentrated in individual holdings and not holding enough cash or emergency safety nets.  You don’t want to be looking for your parachute to only find that it is not there.  It is important to have adequate risk management strategies in place which can often be easily forgotten.

For any further information on what to do with low interest rates, or to discuss how this can affect your financial situation, why not chat to our expert financial planners with a free no obligation consultation.