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Why are interest rates so low?

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Question: Why are interest rates in the banks so low? Will it go up anytime soon and what are the alternatives so my money can earn better?—Dennis Poliquit, Radio DJ

Answer: Dennis, your question is one that you can call a ‘loaded’ question, so to speak (pun intended). Let me try to simplify my answers because the way most people explain it can cause many a nosebleed, me included. In economic terms, interest rates are largely a function of the government’s monetary policy with the central bank as its chief implementor. The government, through the central bank, tries to influence the economy by manipulating interest rates according to the direction of its economic managers. When the government wants money to circulate in the economy, it tries to keep interest rates low with the belief that money will be spent and invested in businesses that drive economic growth. When interest rates are low, people are discouraged from keeping their money with the government, which is the safest and largest borrower through the sale of government securities (debt instruments).

When the government wants to control the cash circulating in the economy, it increases interest rates and you can expect the market to start putting more money in government debt paper because of its low risk. The interest of government securities, also called treasuries (bills, notes and bonds), is also the basis in setting the rates on many other investment products, including bank deposits and corporate bonds. The rates being offered by other institutions (banks and corporations) are higher than those of the government.

This is, of course, only in theory, as the forces of demand and supply will ultimately determine what the interest rates should be.

As to why our interest rates are low now, our government’s monetary policy is to keep them low which, monetary authorities believe, will keep money actively circulating in the economy instead of being parked in government debts. Coupled with a sound fiscal policy (government spending), economic managers hope they can get the economy going (higher GDP). However, this strategy is proving to be insufficient in spurring economic activity as experienced by many countries, ours included.

Some believe the government may start allowing interest to rise as it is difficult to keep interest rates low for a prolonged period owing to supply and demand forces. Judging from the moves and statements of our economic managers, however, it seems their intent is to keep interest rates low.

From a personal investment purview, low rates will take a toll on capital growth of our assets since inflation is rising.

For assets to really grow, they must appreciate faster than inflation rates. The current rates we have, however, are actually causing the erosion of the value of money. For long-term investments, it is unwise to keep money in assets that earn low interests like time deposits, treasury bills and special deposit accounts as they will always have yields that are lower than inflation rates. Investors call inflation as the invisible risk.

To get higher yields, you can try to look for longer-term instruments like treasury notes and corporate bonds. These give higher yields but you will have longer maturities. You can also consider equities or the stock market as an alternative but be mindful of the risks you take.

Another option is to go for pooled funds such as mutual funds or Unit Investment Trust Funds. They are market sensitive funds that are being offered by financial institutions (mutual fund companies, banks and others), which will generally perform better than typical bank deposits. However, they are volatile in nature and carry no guarantee.

In principle, a pooled fund is one that has many investors and there is a professional investment manager to invest for you in accordance with the fund’s objectives. Pooled funds are a good idea because you get to choose from many forms of investments and the entry level is rather low—a minimum of P5,000.

One final tip, before you start shopping for investments, establish your investment objective, time frame and risk tolerance first and foremost, and select the instruments that will be consistent with the three I mentioned. You may also want to check out my event “Steps to Financial Peace” on Aug. 12, 2011, at the Teatrino in Green Hills, where I will be joined by Francis Kong, Paulo Tibig and Jayson Lo. I’ll be teaching personal finance and will delve on investing as well. Details are at http://www.randelltiongson.com/steps-to-financial-peace/

Whew, my nose bled trying to make this column not to cause ’nosebleed.’ I hope I was able to be of help.

(Randell Tiongson is an advocate of Life & Personal Finance. He is a director of the Registered Financial Planner Institute (Phils.) and has more than 20 years of experience in the financial services industry. For questions, write to randell@randelltiongson.com. To know more about RFP program, visit www.rfp.ph or email info@rfp.ph.)


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Tags: Interest Rates , Investments , Personal finance



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