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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)

Weekend Reading: High Mutual Fund Fees Edition

We’ve been beating this drum for years now but a new study by the Canadian Centre for Policy Alternatives suggests that high mutual fund fees could cause Canadians to delay their retirement by as much as 11 years or else leave them with 40 per cent less money for their retirement. The study compares the management fees charged