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Are Low Rates Punishing Savers? Hardly

It’s easy to see how savers feel punished in today’s low interest rate environment. You have to look hard to find a daily savings account that pays more than one percent. Fixed income investments aren’t much better, with 5-year GICs barely touching 2 percent. All of this means that parking your short-term savings will do little more than keep up with inflation – you’re treading water, at best.

We’ve seen a steady decline in rates for the past 25 years – around the time when the Bank of Canada adopted its inflation-control target to preserve the value of money by keeping inflation low, stable, and predictable. In January 1991, the overnight rate was 10.88 percent, the interest paid on daily savings was 9.66 percent, and inflation ran at 6.9 percent. By 2002, the overnight rate fell to 2.25 percent, daily savings interest dropped to 1 percent, and inflation held steady at a now familiar 1.4 percent.

Related: Can you succeed with an all-GIC portfolio?

So should we long for the days when GICs paid 10 percent or more? Are low rates really punishing savers? Hardly. Unless you save an incredibly high proportion of your income, the idea that you can risk-free return your way to a comfortable retirement is absurd because a high real rate of return on short-term saving instruments is neither realistic nor sustainable in the long term.

Inflation

The Bank of Canada raises interest rates to cool inflation so when interest rates do eventually return to normal (whatever that is), it’ll mean that the economy has improved and the cost of goods has increased. It might feel better to get a 4 or 5 percent nominal return on your $1000 savings, but if a basket of goods that costs $1000 today will cost $1040 in a year, the nominal return is meaningless because your real return is zero.

Saving is about putting money aside for future needs. When that future is in the relatively near-term, saving means preserving capital – even if that means earning just slightly more than under-the-mattress interest rates.

Debt repayment

You could certainly argue that artificially low interest rates have fuelled our sky-high household debt numbers. But today’s low rates are an advantage for prudent savers who still carry mortgage and/or line of credit debt.

Low, predictable rates make it easier to juggle financial priorities while raising a family. Who remembers feeling relieved to lock-in a mortgage at 11 percent in 1980 before rates shot up to 21 percent just a few months later? Now we talk about making a game plan for when rates might nudge up by 0.25 percent.

Related: Why baby boomers aren’t prepared for retirement

We’re also fortunate to have the option to consider investing rather than aggressively paying down low interest debt.

Retirement income

Gone are the days (thankfully) when it was assumed that you should sell your entire investment portfolio on the day you retire and put it into ultra-safe cash and GICs.

If anything, today’s low interest rate environment has forced us to think more strategically about our retirement savings. We’re starting to understand that longevity risk is real and there’s a good chance your nest egg will need to last 30-40 years in retirement.

Now we think in terms of buckets – put three-to-five years worth of expenses into short-term savings instruments like cash, GICs, and money market funds, while keeping the rest of your nest egg invested for the long term in order to grow and fight off inflation.

Low rates don’t mean we should blindly reach for yield, but instead we should change our mindset about saving and investing in retirement.

Further reading:

How to use a total-return approach to draw down your nest egg in retirement

Buckets and glidepaths: What to do with your money after retirement

Yes, your being penalized for saving (but keep at it, anyway)

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15 Comments

  1. Sean Cooper, Financial Journalist on March 1, 2015 at 4:15 pm

    Great article, Marie. A lot of people forget low inflation and low rates go hand in hand. I’d much prefer low rates, rather than the hyper inflation we saw during the late 70’s and early 80’s!

  2. Tawcan on March 1, 2015 at 5:18 pm

    Great article. I’m with Sean, I’d rather see low inflation rate than the crazy 10+% inflation that we’ve seen in the past.

  3. My Own Advisor on March 1, 2015 at 7:01 pm

    Some inflation would be a good thing IMO.

    I would argue savers always need to be strategic.

    Given today’s low rates, artificial as they are, savers are being punished. Spenders are being rewarded. I don’t see this trend stopping anytime soon. It may persist for decades to come.

    Just my $0.02!
    Mark

  4. Jon King on March 2, 2015 at 7:40 am

    Great article. Savers shouldn’t feel punished, should value the greater stability, and should be thinking longer-term and more strategically about savings.

    A challenge is however that many people still focus on the nominal rate of return for a GIC or savings account. They look at current rates and figure why bother saving anything.

    For low income earners not prepared to work many savings tools it would also be nice to be still getting 1 or 2 percent in real returns on a basic savings account or GIC or government bond instead of the current zero point something or negative returns.

  5. Barry @ Moneywehave on March 2, 2015 at 8:01 am

    I don’t think low rates punishing savers but it definitely encourages the spenders to spend more or rather for many to pick up debt.

  6. DivGuy on March 2, 2015 at 1:55 pm

    Both situations surely have their ups and downs, but I don’t see low rates as punishing (might be cause I remember my parents difficulties with the super high interest rates too). Actually, I barely count on my account rates for my investments. I rather find great dividends with nice growth. Interests rates therefore become extras! 😉

  7. Chris Beasly on March 3, 2015 at 8:53 am

    John King, unrealistic high stock market, equity market or balanced portfolio annual returns can also impact how much people save.

    If they think that 11%, 10%, 9%, 8% etc. annual rates of returns are the norm for the next 10, 20, 30 years, they will likely save less.

    They would rather spend the extra money that they think they don’t need to save, invest because they are banking on these high returns.

    A simple example, if someone wants to have $1,000,000 in say 25 years in their RRSP’s, TFSA’s and expects a 10% annual rate of return, they would need to save $800 a month but if they expect a more realistic 5.5% annual rate of return, they would need to save $1,587 a month.

    It is a big difference and many people can have hundreds of thousands of dollars less in their retirement that they might need or want.

  8. Cory Papineau on March 3, 2015 at 9:03 am

    Low rates do punish savers. Those that have a high propensity to save are the source of the cheap capital for the spenders. It’s not that these savers don’t have options but the imbalance between low rates and low borrowing costs may but our economy in significant more harm in the long term.

    As Mark says above a little inflation is a good thing both for savers and the economy in general and very beneficial to the Bank of Canada as they would have more wiggle room with monetary policy.

  9. Chris Beasly on March 3, 2015 at 10:27 am

    Cory Papineau, I agree with you to the extent that even central banks or central bankers want a more normal interest rate environment.

    I hear many differing opinions if what normal interest rates should be.

    The most mentioned is 1.5% to 2.00%+ inflation for 1-5 year GIC’s so even a 1.40% inflation rate should mean a 2.90% to 3.40% for 1-5 year GIC’s.

    Savings account rates, short term GIC’s, term deposits 30 days to 364 days should be at about 2.5%.

    Today, they are not even close to that, 1.05% to 2.75% is what I can find for savings accounts, GIC’s rates 1-5 years.

    These cheap interest rates are making people borrow much more and saving less.

  10. Paul N on March 6, 2015 at 6:15 pm

    I disagree with you points on inflation levels. The CPI has been tinkered with so much as to cloud the real rate of inflation. So much of what we need every day has in some cases doubled in cost. Think bacon, cheese, a case of now 12 cans of pop the same price of a 24 not long ago?

    Here is an excerpt from a Time article. Entitled : “If there is no inflation why are prices up so much” I tend to agree with this finding.

    “So why haven’t these more rapid increases shown up in the Consumer Price Index? One reason is that the index itself has been modified in a variety of ways over the past 35 years. Fluctuations in home prices have been smoothed out, for example. And the index has been adjusted periodically to reflect changes in what people buy, particularly if they shift from more expensive items to cheaper ones. Such revisions to the CPI have tended to reduce the official inflation rate, on balance. Various estimates of what the annual rate would have been over the past four years if earlier methods of calculation had been continued come up with numbers in the 5%-to-10% range.”

    So The 2% or less rate of savings you get now is not in line with inflation.

    • Echo on March 7, 2015 at 9:13 am

      Yes, the price of bacon and coffee continue to go up. But what about items like electronic gadgets and appliances? A late-70s VCR cost $1400 (well over $4000 in today’s dollars). Today, you can get a blu-ray player for less than $100. Computers, microwaves, portable music players, and TVs all cost much less today. Anecdotally, the price of clothing ‘seems’ to be the same or cheaper than it was 20-25 years ago. Call it the Walmart effect.

      Gas touched 60 cents per litre in 1990. That means if gas prices just kept up with inflation it should cost 97 cents per litre in 2015 – not that far off today’s prices.

      I’ve tried to measure my own personal rate of inflation and I’ve noted large increases in grocery spending, electricity, insurance, etc. However it’s hard to control for the needs of a growing family – https://boomerandecho.com/gap-between-wage-growth-and-inflation/

      • Essie on March 22, 2015 at 2:37 pm

        The flaw in your argument, Echo, is that we all buy necessities like food, utilities, and gas on a far more frequent and regular basis than gadgets and appliances. I agree that it’s a lot cheaper to buy a TV now, if I happen to need one, but when I look at my non-discretionary spending, I feel like I’m falling behind. I’m on a pension indexed to inflation, so get about 1-2% a year increase, but the increase in cost for the necessities I mentioned earlier often exceeds this – recent gas prices excepted!

        • Echo on March 22, 2015 at 4:34 pm

          Hi Essie, I know it’s tough when we see a huge temporary spike in gas prices, or coffee, bacon, peanut butter, etc – things we consume often. However I do believe that, as a whole, inflation is under control.

          Look at the cost of natural gas, for example. In 2007/2008 there was a huge spike and the price was over $13/mmBTU. Since then there was a sharp decline and the price has hovered between $2 and $6 for the past six years. That means low, predictable costs to heat your home.

          I know from our own grocery budget that the price of meat has gone up a fair bit over the years – certainly more than the CPI. But we’ve adjusted by eating less of it, smaller portions or more meatless alternatives.

          You’re fortunate to have an inflation-indexed pension – many don’t – but I can understand why you feel like you’re falling behind. That’s why, as I mentioned in the article, that many retirees still need exposure to equities for their long term savings in order to combat inflation.

  11. Kevin on July 9, 2015 at 8:13 am

    I like your posts. I read the one about RRSP and RESP before mortgage and totally agree. I also think you’ve hit the nail on the head with its real rates that matter more than nominal rates. But I shake my head at todays rates because:

    – Those that have already saved are fine. They got massive capital appreciation in their house, bond and stock portfolio as rates dropped. The true people that are being punished are those that are just showing up to the game right now (millenials, gen X, last minute baby boomers).

    – Things feel great as inflation / rates are dropping and asset prices are rising, but what happens when inflation / rates go back up and at the same time financial prices drop?

    – Today’s ultra low rates have allowed governments, corporations and households to accumulate crazy debt loads that won’t be sustainable if rates ever rise again. 1% -> 2% means service costs double.

    So I agree that low interest rates don’t punish those that have already saved, but young people trying to save right now could be in for a rough ride soon.

    • Echo on July 9, 2015 at 8:53 am

      Hi Kevin, thanks for your comment. You raise an interesting point. I often wonder, too, if all the housing bears have a generational bias. The older generation who bought houses for $50k in 1975 can’t fathom the idea of paying ten times that (or more) today. They also remember when mortgage rates hit 18-20% and are most likely the ones saying that situation could happen again.

      I agree that something has to give when it comes to housing prices – they can’t go up forever. But we’ve been saying rates are at historic lows and have nowhere to go but up for six years. And it sounds like the BoC is going to cut rates even further at its next meeting.

      Bottom line is that when it comes to borrowing, low rates are not an excuse to borrow beyond your capacity. Understand the impact of a 2-3% rise in interest rates and make sure it fits with your budget.

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