So Where Does the Money Go?

BY COLIN WHITE | PORTFOLIO MANAGER, WLWP WEALTH PLANNERS & IA PRIVATE WEALTH

Lower interest rates were great for new home owners and borrowers - but they weren't so hot for elders who rely on pensions and investments.

Higher interest rates are hitting hard for those on the borrowing side of life, typically the younger generation. From their point of view, it is money out of their pocket going to the bank or financial institution from which they are getting their loan. So the inquiring mind wants to know, “Do they get to keep all the money?”

It would seem evil if some wicked empire arbitrarily got to increase interest rates and keep the money for themselves, and indeed that would be evil. The key to understanding this is to zoom out and see it from all sides.

Every day trillions of dollars trade hands in the form of bonds and other debt instruments. Countries, companies, not-for-profit organizations, pensions, and individual investors have needs for guarantees, which change over time. This trading happens in an open market. There is no price set; the price is what the players in the market are willing to pay. What they are willing to pay is influenced by many things, but part of it is their expectations for the future; other parts include the actions of the central banks.

The central banks only control the overnight lending rate. This influences the market because if I can get a 4% rate on a daily interest basis, it will take a higher return for me to lock my money up for a year. If a client came to me and wanted to set money aside, I would look at the overnight rate and consider if there is a higher rate if we lock the money up for a more extended period. For each person, the reward for locking money up would need to satisfy their situation, so there is no single percentage that everyone would take. The higher the rate, the more likely people would choose to lock up their money.

Why does this matter? Borrowing rates are tied to savings rates. If an institution needs to pay someone 5% to get them to lock their money up, they need to lend it out for more than that to make a profit. Every lending institution has a cost of capital, and they need to lend money out at a rate higher than that to make a profit.

The other wonder of the world is how the system self-levels. Housing prices have been very strong for the last number of years. These higher interest rates have brought those prices down. Where the market works perfectly, the monthly payment with a higher purchase price and lower interest rate is the same as the lower purchase price with a higher interest rate, with the bonus of needing a lower down payment amount.

For the longest time, borrowers have had a great ride with extraordinarily low interest rates. At the same time, pension funds and retirees have struggled with very low investment rates. In this current climate, it is easier for pension funds and individual investors to achieve their investment goals.

This information has been prepared by White LeBlanc Wealth Planners who is a Portfolio Manager for iA Private Wealth. Opinions expressed in this article are those of the Portfolio Manager only and do not necessarily reflect those of iA Private Wealth Inc.