Would you pay a bank to store your money in their laser-guarded vaults? Ideally not, but that’s the reality for some as negative interest rates have spread from Japan to take hold in Europe – and now lap the shores of the UK.

What are negative interest rates?

Negative interest rates mean that a central bank has cut one of its main interest rates below 0%. Instead of the central bank paying interest to commercial banks, the relationship is turned upside down and now those banks must pay a charge to keep their cash on deposit. The idea is to force commercial banks to loan out money and stimulate the wider economy instead of hoarding cash when a major recession looms.

When faced with negative rates, a bank is theoretically better off making even a 0% loan rather than losing money on cash stashed with the central bank.

Needless to say, negative interest rates are a bad sign – a desperate call for all-hands on the money pump when the economy looks like an extra from Dawn Of The Dead.

Negative interest rate policy (NIRP) has also been used by central banks to weaken demand for their currencies in a bid to protect their country’s export industries.

Countries with negative interest rates

Countries with negative interest rates include:

• Switzerland: -0.75% (SNB Policy Rate)
• Denmark: -0.6% (Nationalbanken CD rate)
• Eurozone countries: -0.5% (ECB Deposit Facility Rate)
• Japan: -0.1%

The Danes went below zero in 2012 (they hit a low of -0.75), the Eurozone in 2014, and Japan in 2016. The Swedish central bank rate also went negative in 2015 and dipped as low as -0.5%. But the Swedes had tunneled back up to zero by January 2020.

The main central bank interest rate in the UK is the Bank Of England’s Bank Rate (or Base Rate).

Bank Rate currently clings on to positive territory at 0.1%.

What do negative interest rates mean for savings accounts?

The great fear with negative rates is that you’ll have to pay your bank to park cash with them. That would erode the value of your savings as surely as water wears down soap. You could be better off stuffing your cash into the proverbial mattress.

And indeed this appears to have happened.

There are reports of German customers putting physical notes in home safes and bank vaults as an alternative to paying charges on deposits of more than €100,000. Physical storage spares customers the charge they’d incur if their money was lodged with the ECB.

Multiple Swiss banks also started charging high net worth customers a 0.75% fee on saving balances over two million Swiss Francs (CHF). That means it’d cost you 7,500 CHF per year for the pleasure of saving three million CHF in your account (tiny violins).

As you can imagine, business customers are hit by this, too. It’s hard for a law-abiding small business to make their cash magically disappear.

A case for cash? Negative interest rates would be easier to impose more widely on a cashless society because its citizens wouldn’t have the option to divert notes from the maw of a negative rate account to a box in their basement instead. Could the spectre of negative interest slow down the adoption of payment apps? At least we wouldn’t have to worry so much about grandad not being able to buy groceries because he never remembers to charge the smartphone he doesn’t know he has.

Imposing negative interest rates on wider swathes of society isn’t inevitable and is highly charged politically. The outcry in the UK would likely reverberate like the death of Alderaan if we’re ever stung for a percentage of our savings. And imagine the headlines the first time a pensioner’s biscuit tin was stolen – their life savings gone because of some banker’s negative interest rates.

It’s possible for central banks to shield consumers from the pain of sub-zero rates. For example, the ECB doesn’t charge on the first-tier of a bank’s deposits.

The local banking market also matters. Do banks rely on deposits as their chief source of funding? Is there a competitive market that empowers people to switch banks in a mad hunt for a few tenths of a percent of interest? If so banks could be reluctant to put off their customers with negative rates.

Even without negative rates in the UK, savings rates have been slashed as Bank Rate has sunk to just 0.1%.

It’s not hard to imagine a world in which savings earn nothing.

Negative interest rates: mortgages

What about mortgages? The dream is a bank would pay you to take its money, you’d buy a Scottish Castle, never pay a penny back, and the debt would melt like a snowman.

But that’s probably not going to happen.

There were some excitable reports that the Danish Jyske Bank had offered the world’s first negative interest rate mortgage. But the less exciting reality was that customers were still paying the bank after it had slapped on various fees.

A few lucky punters thought they’d hit the negative interest mortgage jackpot in the UK in 2009.

They were on two-year tracker mortgages that offered the Bank Rate minus a slice ((A discount of -1.01% was offered by Cheltenham & Gloucester at the peak of the 2007 mortgage madness)). But the banks never did pop them a cheque in the post. Instead those blessed borrowers got a 0% interest rate for a short while – which is still free money. On a house!

After that fright, the banks tightened up the small print so that they will never pay you to borrow. Many inserted ‘collars’ that mean your mortgage rate won’t fall below a certain level.

Still, as with saving accounts, you can expect negative interest rates to push mortgage rates downwards. Which sounds great until we start fretting about potential unintended consequences:

• Reduced mortgage competition and choice because lending is less profitable for banks near-zero.

• House price inflation as happy borrowers go large in the face of historically low rates.

• House prices collapse if interest rates rebound and the once-happy borrowers go bust.

Negative interest rates: negative consequences

The concern has always been that once you start experimenting with NIRP psychedelics you can’t go back to the old normal.

It’s not hard to find authors of articles from the 1990s poking fun at Japanese zero rates like they were Chris Tarrant sneering at the gameshow Endurance.

And yet here we are, with near-zero rates abounding.

As sci-fi author William Gibson once said: “The future is already here – it’s just not evenly distributed.”

It’s easy to understand why central banks have slashed rates around the world.

Their first priority is to stop a biblical recession that would make even Friedrich Hayek blush.

But beyond that, the discourse is ablaze as to whether the habitual use of negative rates is good for anything apart from maiming banks, jeopardising pensions, and distorting markets.

Nobody knows for sure – the experiment is still coursing through our system – but here’s a potted tour of sub-zero anxieties:

Reverse psychology

Negative interest rates are widely seen as ‘weird’. They unsettle people and seemingly spooked some consumers and corporates in Japan because they believed that such extreme measures signalled that the Bank of Japan knew something awful was coming.

Hobbling the banking system

The Bank of England reportedly rejected negative rates during the Global Financial Crisis because it feared they would push tottering banks and building societies into bankruptcy. As if things weren’t bad enough.

Negative interest rates narrow bank profit margins, which could ironically reduce their capacity and willingness to lend.

One of the lessons of the financial crisis is that we like our banks to be safe and boring. You know – the kind of stuffy old prudentials that maintained massive cash buffers because they’d only lend you money if you were an earl or married to the bank manager’s daughter.

Another sub-zero misgiving then is that negative rates could erode the very cash buffers that are meant to safeguard the system in times of financial stress.

Stymied stimulus

If negative rates squeeze banks’ profit margins to the extent they rein in their lending to consumers and businesses, then would-be easy money policy has gone from stimulating growth to strangling it. Financial nerds call this the ‘reversal rate’. (Because what’s a bit more interest rate jargon when we’re having fun? Or a depression?)

Mis-selling scandals

It’s been a while since we’ve heard about our friendly local bank forcing its staff to adopt the kind of high-pressure sales tactics that belong in a boiler room.

Flog a loan, a structured bond, a credit card (would you like PPI with that?) – anything so long as the boss got his bonus.

But the rush to get money off the books in sub-zero Denmark has been blamed for banks pushing risky products onto unsuspecting customers. The regulator called in the police to investigate Danske Bank over the affair.

So much for hygge.

Delinquent debt

We won’t be paid to swipe our credit cards, buy a Tesla on HP, or to live in our dream house, but negative interest rates are at least meant to make it easier to get the loans to do such things. Reckless lending in NIRP world isn’t so much a moral hazard as a patriotic duty. But the risk of burying the system under a collapsing Jenga tower of bad debt is obvious.

Asset price bubbles

Another source of disquiet since the financial crisis is that easy money just flows straight through our fingers and into assets like equities. ((Note from The Investor: Much QE money never actually goes into the real economy to touch our grubby hands at all, but nevertheless by flattening the yield curve it does drive investors into riskier assets – such as shares – which amounts to the same thing.)) Instead of stimulating the real economy, the money might exacerbate income inequality, prop up zombie companies, and turn the stock market into a giant Ponzi scheme. Such accusations remain unproven but the dread is only amplified by negative interest rates.

Unfair on savers and pensioners

The effect of negative rates spills over onto savings, bonds, and annuities, with painful implications for those who rely on low-risk returns to maintain their standard of living.

The ECB had to change the rules to prevent Dutch pension funds cutting their payouts, for example, while Swedish insurers have apparently increased their exposure to equity markets in a titanic reach for yield.

Stretching for yield on a personal level is an obvious threat as retirees head into riskier asset classes in a bid for return – think junk bonds, emerging market debt, volatile risk factors, and, god forbid, leveraged products. The danger of people getting in over their heads and panicking if it goes wrong is clear and present.

Currency war

Most of the central banks who’ve gone negative have done so in part to devalue their currency and increase the competitiveness of their export industries. If other central banks choose to tit-for-tat then we could end up in a beggar-thy-neighbour spiral. That didn’t turn out so well in the 1930s.

Does it even work?

The general narrative is that negative interest rates seem to work in the short-term to ward off deflation and stimulate the economy.

But many argue that sub-zero is addictive and doesn’t facilitate recovery in the long-term.

Only Denmark popped its head back above the zero bound for a few months in 2014 before going back under. Sweden made it back to zero in the first few months of 2020 and then the coronavirus hit.

Negative interest rates: UK

Most of the dangers listed above were contaminating our financial system long before NIRP. I make no claim to know whether they are really exacerbated by negative interest rates.

Perhaps there wasn’t much choice anyway, but everything I’ve read on the subject suggests you wouldn’t want to start from here.

So do we face the same negative rate future in the UK?

All we have to go on are the gnomic utterances of Bank of England officials. Former governor Mark Carney took sub-zero rates off the table, only for new guv Andrew Bailey to put them firmly back on the table again.

Bailey didn’t sound keen though when he told MPs:

We do not rule things out, as a matter of principle. That would be a foolish thing to do. But that doesn’t mean we rule things in either.

An alternative to negative interest rates is a Keynesian fiscal stimulus that spurs the economy through massive government spending. That looks like it’s actually happening, given borrowing is being thrown into overdrive courtesy of that arch-Keynesian Boris Johnson.

Truly we live in Bizarro World.

Negative interest rates: bonds and real yields

The negative interest rates imposed by your smiley bazooka-wielding central bank are not the same as the infamous negative bond yields reported in the financial press.

Bonds inflict a negative yield when their asking price outweighs any remaining interest payments, so that investors suffer a loss on the bond if they hold it to maturity.

Negative real yields occur when inflation is higher than nominal interest rates. For example, a 2% cash deposit pays a real yield of minus 1%, if inflation is 3%. The UK is no stranger to this.

Negative interest rates: key takeaways

• Negative interest rates happen when a central bank lowers one of its main interest rates (often the deposit rate) below zero.

• It’s an extreme monetary policy designed to force commercial banks to make cheap loans in order to avoid paying to deposit money at the central bank.

• Negative interest rates are believed to ward off deflation in the short term and to stimulate the economy. There may be negative side-effects in the long term.

Take it steady,

The Accumulator

What caught my eye this week.

With hundreds of investing blogs having published thousands of articles over the past decade, there’s a lot of repetition around.

(Indeed I’m getting déjà vu. Didn’t I say much the same the other week?)

Anyway, you have to admire a post that finds a new spin – such as combining astrophysics and economic upheaval, as Klement on Investing did this week.

Especially when it brings – ahem – gems such as this:

The chaos of the universe is needed to create new structures. And islands of order like a star and its planetary system eventually disintegrate into chaos out of which new structures are created.

A wonderful symbol for this order out of chaos is the fact that on Neptune, the atmosphere is so volatile and chaotic and the pressure is high enough, that scientists suspect it sometimes rains diamonds on it.

Wow. I wonder if Elon Musk is short Tiffany, the upmarket jewelry store?

Let there be… light entertainment in the interlude

Klement’s argument is that the confusion and misery of Covid-19 will similarly produce much of value in time.

But it seems a stretch to compare diamond showers on faraway worlds with people working in their pants and not shaving for a week, or with Starbucks staff serving coffee from behind a 2″-thick plexiglass screen. ((Who is making all these screens? There’s a Covid-19 winner for sure.))

When it comes to our investing beat, the disruption is mostly just more oddness, which is at least on-brand with the times we’re living in.

CNBC veteran Jim Cramer, for example, is using his airtime to lambast the antics of the lockdown day-trading generations’ Pied Piper – the Internet entrepreneur Dave Portnoy.

There’s probably 50 years separating the demographics of their target audiences, but I’m sure they’re united in enjoying the spat.

Who knows what happens next. We seem to have run into an air pocket – in the markets, in the global Covid-19 narrative, and in the economy – where everything is neither getting better or worse, at least for a moment.

Normality returning? Or maybe we should hold on to our hats (and our diversifying safer assets…)

[continue reading…]

Today’s new traders aren’t paying dealing fees with Freetrade. But there are plenty of other costs to overcome.

There’s stamp duty, spreads on shares, platform fees, and if you do well even taxes (though these can often be avoided – see point #2 below).

More importantly, most people can’t pick stocks to beat the market.

They have no ‘edge’, in the lingo.

That includes most fund managers, incidentally. Most of their funds lag the market, too. (It’s all because active investing is a zero sum game).

A potentially costly business

That’s not to say you can’t buy a bunch of shares that will go up.

In a market that’s been flying higher like we’ve seen for the past two months, it’s easy.

But most of the time you would have done even better just to put your money in an index tracker fund and gone back to those Udemy cookery lessons.

Most things go up in a bull market.

12 tips to help you make money investing in shares

I’m not going to labour the point about passive investing in index funds today.

You opened your new trading account for excitement, not something that’s just as dull to do as it sounds – even if it is more profitable.

I’ll mention it again before we’re done (Monevator believes index funds are best for nearly everyone) but let’s assume you want to invest in individual shares to make money.

You want the glamour of being a high-rollin’ ball-bustin’ share trader!

Sitting on your sofa in your Gymshark shorts on your iPhone!

Here’s a dozen pointers from someone who has been striving to beat the market for nearly 20 years.

My tips might help.

A bit.

1. Keep costs low and trade less frequently

A commission-free broker like Freetrade is a great start, but remember UK investors also pay 0.5% stamp duty when buying into most larger UK shares. There’s a bid/offer spread on shares, too – same principle as when you change currency at the airport – and if you buy overseas stocks there will be a foreign exchange cost. Churning your portfolio every few days quickly multiplies these costs. With most platforms (though not entry-level Freetrade) there are annual charges, too. Check out our comparison table to find the best platform for you.

2. Use tax shelters – in the UK that’s ISAs and SIPPs

Even Freetrade charges £36 a year if you want to do your trading in an Individual Savings Account (ISA) while other platforms charge you to do so in a Self-Invested Personal Pension (SIPP). Despite the nailed-on expenses, you should bite their arm off and open them. In theory small-time traders can muck about without worrying about taxes on capital gains and dividends, but as your pot grows, taxes loom. Use an ISA and you can forget all about taxes, while a SIPP defers any pain until you retire. (More on tax-efficient investing and ISAs vs SIPPs).

3. Don’t blindly buy strangers’ share tips

It’s fine to read the better blogs, financial Twitter, and forums to learn about investing. You can learn a lot from smart investors who share how they think. But be wary of people touting their specific trade ideas – unless at least halfway vetted and presented in some depth, on a venue like Seeking Alpha or The Motley Fool – and run away from anyone urging you to get in NOW because it’s “about to go ballistic”. They’ll usually be clueless, cheats, scammers, or some exotic combination. Even if they’re not – is that how you’ll invest for the rest of your life? Following strangers ramping stocks online? Does that seem a likely route to wealth to you?

4. At our level, technical analysis doesn’t work. It’s horoscopes for grown-ups…

Most of these Internet hucksters will urge you to look at charts. They will talk about reversals, channels, double-tops, breakouts, and sacrifice chickens to the moon. The quickest and easiest summary of what you should do is ignore it all. It’s true that some ultra-sophisticated hedge funds find trading signals in price information (read The Man Who Solved The Market) but Barry on his iPad isn’t one of then.

5. …although you should favour shares where prices are rising over those falling

The one bit of price action it’s worth paying attention to is momentum. You’ll probably get better results if you buy shares the market seems increasingly keen on (a chart where the price is going up over time) versus one it seems to dislike (the price is sliding). The market isn’t stupid. It usually figures out when a company has something good going on. Also, momentum is a factor that can give a slight edge to a portfolio. (I’m hugely oversimplifying. That’s what happens if you don’t want to read a 480-page book…)

6. Don’t get carried away with value investing  ‘fundamentals’, either

Most people eventually realize that trying to guess where shares will go by looking at their price charts isn’t making them any money. They may then dive in the other direction to study the metrics of a company/share. Things like the price-to-earnings ratio (a measure of how much you pay for profits), dividend yield (the cash you get back every year, if you’re lucky), or the book value (what, in theory, the company is worth, if things like Coca-Cola’s brand name weren’t in reality worth billions). That latter point gives you a clue as to the can of worms you’re opening. Yes, learning to understand these fundamentals is vital, eventually, and far better than watching random chart squiggles, but it’s a huge undertaking that’s prone to gross simplification. You only need to utter “this share is a bargain because the P/E is 3 and it yields 15%” once before a company goes bust to realize the numbers don’t tell you everything.

7. Instead, think about shares as businesses

This one might seem blindingly obvious, but even experienced investors often forget stocks are not an abstract mathematical artifact – they are mini-ownership stakes in businesses. When you buy shares you buy a part of a company that faces opportunities and struggles, and that’s striving to grow with the economy. This is what enables stock markets to go up over time (rather than being a futile piece-of-paper-shuffling racket as some believe). Analyze your shares by understanding them as companies. I believe you’ll eventually see much better results. This also connects your investing to the everyday world around you, which is a far more interesting way to live!

8. Be wary of ‘story stocks’

One danger with looking at shares as business propositions though is that you can be seduced by a good story. Every stock picker has been tempted by a tiny miner just months away from striking gold, a biotech about to cure cancer, or a manufacturer with a prototype engine that runs on old Amazon packaging. Also known as ‘blue sky’ stocks (because there’s often nothing to them) these are speculative ventures that should get – at most – a tiny percentage of your money and time.

9. Invest for the long-term: run your winners, and cut losers

At first, you think it’s all about buying low and selling high. That it’s never wrong to take a profit. That falls in markets are due to ‘profit taking’. And all of this makes sense if you’re a trader who lives or dies on your rules or system. But as I said, most people shouldn’t be traders. Be an investor. And when you invest in companies for the long-term – think years – the best can multiply in time many times over. I put 1% of my portfolio in Amazon a few years ago, and it’s gone up ten-fold. That kind of growth makes up for a multitude of small losses, but it’s too easy to sell up along the way. Remember, the most you can lose on a stock (assuming you avoid margin/leverage) is as much as you invested, but your gains are theoretically unlimited. One of the most successful stock pickers of all-time never sold anything.

10. Realise the stock market does not move in step with the economy

Another thing some people never understand. The market is not giving you a running tally on the economic headlines. There is a strong connection, certainly, between the real-world economy and the market. As I said the market consists of companies operating in the economy. But because investors can bid up or crash the prices of those companies for myriad reasons – hope, fear, greed, miscalculation, laziness – the two often seem out of kilter. In early 2020 markets started falling before many of us had even heard of the virus. They then rose as tens of millions lost their jobs. This seems bizarre until you understand markets look forward into an uncertain future. People are constantly trying to predict that future when they select what firms they want to own (or sell) and what price to pay, based on how they see things going.

11. Benchmark your performance (possibly)

If you’re going to be an active investor – as opposed to a passive investor using index funds – then you should probably track your returns accurately, and compare (benchmark) your performance against the market. The best way to do this is to unitize your portfolio. This enables you to properly compare your returns with any active or index fund. If after a few years you see you’re deluding yourself that you have edge, you can stop the bleeding! The reason I say ‘possibly’ is that tracking returns can encourage bad investing behaviour. You can get too short-term focused, trade more often, and simply get stressed. This is something I struggle with. Investing is a passion for me, and I sometimes think I should go back to not tracking my returns because I suspect I did better in those laid back days. But, of course, I don’t know that I did, because I didn’t track then…

12. Make a start with a passive index investment, on the side

An easy compromise is to split your investment money in two, and to put half into an index fund and half into your stock picks. You can do this even on a share-trading platform like Freetrade or Interactive Investor by buying a world index-tracking exchange-traded fund (ETF). Assuming you don’t add new money to your portfolio you’ll get a sense of how well you’re doing compared to your benchmark, that ETF. (If you do add new money, invest it equally between your ETF and your other shares to keep the comparison straight.) If after a couple of years you’re not adding value compared to the ETF, then sell your individual shares, invest in a proper passive ETF portfolio, and get yourself a new hobby. You’ll almost certainly end up richer as a result.

Put these on your reading list

What if you find you’re one of the rare few with the strange combination of personality traits required to make it as a market-beating stock picker?

Or if you really want to maximize your chances, at least?

You need to stop reading FinTwit and start reading books.

I have read over 100 books on investing, easily. Most of them had something to teach.

Here’s a rather eclectic list to get you started:

• The Art of Execution – One of the very few books about how to actually go about building – and pruning – a portfolio for profit.

• You Can Be A Stock Market Genius – Stop looking in the obvious places for your investments. Hunt out hidden advantages. The examples are dated, but the mindset is timeless.

• One Up On Wall Street – Again, dated examples, but you won’t find a better book on thinking like a business owner even as a spare bedroom investor.

• The Snowball: Warren Buffett and the Business of Life – Because it’s good to have goals.

• Investing Demystified – The case for passive investing from Monevator contributor Lars Kroijer.

If you want to try share trading, do so for free with Freetrade. Sign up via that link and we both get a free share. You’re already winning! The Interactive Investor and Amazon links are also affiliate links. This is a marketing cost for them, and doesn’t affect what you pay.