Low rates here for a while

The current low-interest rate environment is not likely to end any time soon, and that has major implications for your retirement savings.

Many people expressed surprise when the Bank of Canada cut interest rates by a quarter-point in mid-July. But the move made a lot of sense and I expect more to come before the year is out.

A major reason for the Bank’s decision was that the loonie was simply getting too big for its britches. Corporate profits have been hurt and that in turn means lower tax revenues for already hard-pressed governments. Factor in the general slowdown in the Canadian economy and declining inflation and the rate cut was almost inevitable.

On the same day that the Bank of Canada made its move, Federal Reserve Board chairman Alan Greenspan told the U.S. Congress that deflation remains a serious concern. He stressed that it is an unlikely scenario but warned that it could be devastating for the economy if it were allowed to take hold. The Fed chairman said that U.S. rates, which are already at 45-year lows, could be cut again if necessary to combat the deflation dragon. And he predicted that rates may remain at low levels for some time to co.

This means that the low interest rate environment that we’ve been experiencing is not going to vanish any time soon. Here’s what that means to you.

Next page: What might go up; what likely won’t

* GIC rates, which are at levels we haven’t seen in decades (2.8 per cent on a five-year term at Royal Bank) are going to stay down. Many retirees and RRSP savers have money in these certificates. What you may not realize is that, unless you give the financial institution other instructions, GICs are automatically rolled over at maturity into new certificates with the same term. So if you have a five-year GIC coming due soon, you’ll be locked in for a new five-year term at the current low rates unless you take action. My advice is that you do so. Rates are almost certain to be higher than they are today within the next five years. Locking in now means you won’t be able to benefit from future increases. If you want to remain in GICs, tell your bank to roll over maturing certificates for a shorter term. Otherwise, look for other investment options. Don’t lock in for the long term at these levels if you can possibly avoid it.

* Money market fund yields, already minuscule, will decline further. Don’t keep a lot of cash in these accounts. A no-load mortgage fund or short-term bond fund is a better choice. They provide higher potential returns with only slightly more risk.  U.S. dollar money funds are even worse assets than Canadian dollar MMFs right now as they will return almost zero interest.

* Mortgage rates will remain attractive, which will continue to support the housing boom. If your mortgage is coming up for renewal, you might want to go for a variable rate, which is the lowest you’ll get. But be ready to lock in for a longer term if the economy starts to pick up steam because rates won’t stay this low forever.

* For income trusts, the interest rate news is mixed. Lower interest rates translate into reduced yields for trusts, which is bad for new investors. But they drive up the market price of quality trust units, which is great if you already own shares. If you plan to make new purchases because you need the cash flow, be very selective. Focus on top-quality trusts, with a sound distribution record.

In short, what we see is what we’ll get for at least the next six months to one year. The Fed won’t change direction until it is clear that the U.S. economy is truly in a strong recovery mode, and the Bank of Canada is very likely to take our own rates down another peg or two. This means you need to adjust your retirement savings strategies accordingly.