The End of Cheap MoneySubmitted by Justin Hayek on July 12th, 2017
Its taken about 7 years but it finally happened - the Bank of Canada raised its key interest rate. Though the rate increase was not much in absolute terms (from 0.50% to 0.75%) the path has been set and the implications to your finances and investments - your financial well being - may be huuuuuuuge (as Donald Trump would say). Here's why:
But before we get into the implications, some debunking. I can already imagine some readers thinking 'so what...0.25% of an increase is nothing'. True but the event of this albeit small rate increase says everything. The Bank of Canada has now started down the path of increasing rates. This means several more rate increases to come. So too think the economists at Scotiabank, TD Bank and BMO.
Historically, the Bank of Canada has moved its key interest rate in the same direction several times consecutively (6.27 times on average to be exact) before going the other way. The US Federal Reserve historically moves rates 7.5 times in the same direction consecutively. Therefore if history is a good gauge, you can expect the key interest rate to rise from 0.50% to about 2%.
|Date||% Rate Increase/Decrease||Number of Consecutive Moves in Same Direction|
|Mar. '96 to Nov. 96||-2.00%||9|
|Jun. '97 to Aug. '98||+2.75%||6|
|Sep. '98 to May '99||-1.25%||5|
|Nov. '99 to May '00||+1.25%||4|
|Jan. '01 to Jan. '02||-4.00%||10|
|Apr. '02 to Apr. '03||+1.25%||5|
|Jul. '03 to Apr. '04||-1.25%||5|
|Sep. '04 to Jul. '07||+2.50%||10|
|Dec. '07 to Apr. '09||-4.25%||10|
|Jun. '10 to Sep. '10||+0.75%||3|
|Jan. '15 to Jul. '15||-0.50%||2|
What does this mean for you and your financial well being?
That all depends on if you are a saver or a borrower. That's because the Bank of Canada's key interest rate has the ability to move interest rates on all types of savings, investments and debts. If you are a saver - rejoice! Expect higher rates on your deposits, GICs and just about any investment that pays you interest. If you are a borrower, pay off your debt!
How can you benefit?
Through your investments of course! If you have not positioned your investments to benefit because you are unsure how, what we've been suggesting to clients is ETFs with exposure to a diversified portfolio of preferred shares (or "prefs"). Reason for this is as interest rates rise so too do the price and dividends of these ETFs. Three benefits to an ETF of preferred shares:
- Monthly Cash Flow - the Pref ETFs we use for clients pays a consistent and dependable monthly dividend. Also offers tax benefits too
- Reduced Risk - Because of the number of individual preferred share issues (over 200) held in an ETF, this offers plenty of diversification and therefore reduces risk
- Less Volatility - This is also a function of diversification. Most indivdual prefs don't offer enough daily trading thereby forcing you to pay up sometimes several percent to buy
What to be careful for
If you are a borrower and have significant debt, be careful. Even an increase from 0.50% to 2.00% on the bank rate can mean a world of difference on your debt payments.
Imagine you have a mortgage of $300,000 ( which is the appx. average in Vancouver) at 2.00%, with 25 years amortization, monthly payments would be $1,270.35. In a rising interest rate environment, which we're now in, borrowers are forced to refinance at a higher rate. Say by the amount we discussed +1.50%. Your new mortgage rate is 3.50%. What does this do to your mortgage payments? Well they balloon from $1,270.35 per month to $1,497.81. An increase of almost $230 per month or 18%. Not much you think, but its scary to know that 56% of Canadians polled are unable to handle an additional $200 of monthly debt payments - this makes them near insolvent.
If you are interested in knowing more on how to benefit from what's to come we can help. Contact us today to discuss.