Assessing the Value of Time & Interest Rates

by Scott Smith, CIMA®

Rising & falling interest ratesHave you ever thought about what an interest rate actually means? It’s a rate that compensates a lender or investor for the time value that their principal is invested. The question then becomes how to measure the value of time and the answer is relative to the perceived riskiness of the borrower and inflation expectations during the time period invested. The low interest rate environment that is occurring in unison across the developed world is fascinating. Together, they are telling a story that investors need to pay attention to. Below is a table of 10-year government bond rates & accompanying debt/GDP across several different countries in Europe & Asia.

Interest rate value

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Use Caution When Investing in These Asset Classes

by Scott Smith, CIMA®

Asset ClassesWhat do Real Estate Investment Trusts (REIT’s), Utilities, and long-term bonds all have in common?  They are all income-oriented asset classes that are price sensitive to movements in interest rates.

As interest rates moved lower in 2014, prices on these three asset classes moved up by 30.36%, 26.99%, & 19.72%, respectively, in 2014.  In January 2015 alone, 10-year treasury rates dropped from 2.12% to 1.66%, which again helped REIT’s, utilities, and long-term bonds move higher by 6.85%, 2.18%, & 6.64%, respectively.

It’s easy to be enamored with investment returns, but we caution investors against chasing after these asset classes at this time due to the fact that 10-year & 30-year treasury yields are now approaching their all-time low.  These noteworthy performance gains illustrate how declining interest rates can move interest-sensitive asset prices well beyond their fair value.  If there is upward movement in interest rates as the U.S. economy continues its recovery, these asset classes will be vulnerable to a sizable price correction.  Investors seeking income should look elsewhere.