Interest Rate: It Is In Your Interest To Know It
Not sure about you guys, but when I was growing up during my schooling days, I hardly hear my parents discussing the stock market. Occasionally they do speak about the property market but most of the time, it was either a conversation on fixed deposit (FD) or Employees Provident Fund (EPF).
Now in my mid-30s, well at least from my point of view, I’m noticing many of us are talking about the stock market. Some of us do spend money attending courses learning how to trade and invest in the stock market. There are some into the forex (FX) market and derivatives market too. We tend to treat it as a second or part-time job.
In my previous post on risk, I shared the below diagram illustrating the risk associated with each asset class. As shown, FD and EPF investments have lower risks compared to stocks. This then begs a question, why are we into riskier investments compared to our parents’ generation?
I can think of some plausible reasons and one of them could very well be due to exposure. Now in the information age, we have access to information and many platforms to choose from. With the rise of online trading, opening a trading (CDS) account and trade during working hours (ahem) made easy. And with exposure comes knowledge and experience, which I suspect was lacking back then. The initial capital required to trade or invest could be a barrier too.
Or could it be we as a generation as grown greedier? 🙂 What about the cost of living, higher household debt level and stagnating income growth? Maybe consumerism has something to do with all these and may have left us with no choice but to look for higher returns with higher risks elsewhere.
I don’t have a definite answer. At best I reckon all the above factors may have played its part in getting us into riskier territory. But what if there was a simpler explanation of these phenomena? What if the interest rate is the root cause? Well, let’s explore.
For a simpler understanding, I’m going to take the fixed deposit (FD) rate as the benchmark for Malaysia’s interest rate. Usually, the FD rate is slightly higher than the interest rate set by Bank Negara Malaysia (BNM). For example, the interest rate in 2018 was 3.25% while the average FD rate was around 3.30%.
Another reason I have chosen the FD rate is that from an investor’s perspective, it bears the lowest risk. Meaning, investor’s capital is always preserved and at the end of the investment tenure, he or she will be rewarded with the agreed fixed rate of interest. Simply put, there are no surprises. Investors know what they are getting when they invest in FD.
FD vs CPI
Above is a chart of Malaysia’s 12-month FD and inflation (CPI) rate from 1981 to 2018. To calculate the real rate of return (RRoR), just subtract CPI from the FD rate. (We should always consider inflation when it comes to investment.) For example, the real rate of return for the year 2018 is:
FD Rate (12 month) = 3.30%
Inflation Rate (CPI) = 1.00%
Real Rate of Return = 3.30% – 1.00% = 2.30%
Now, we can break down the chart into a few main periods.
1. 1981 economy crisis
2. 1982 to 1989
3. 1990 to 1998 (the economic boom period for the ASIAN region)
4. 1998 ASIAN financial crisis
5. Post 1998 ASIAN financial crisis until 2008
6. 2008 global financial crisis (GFC)
7. 2008 GFC to date
Each period has its own story to tell, but I’ll stick to the objective of this post “Why are we into riskier investments compared to our parents’ generation?” Maybe, the below observations from the chart can lead us to the answer.
Malaysia’s FD rate:
1. Drops significantly after each financial crisis
2. Has been shrinking from decade to decade
3. The real rate of return (RRoR) has been shrinking from decade to decade
FD vs CPI Average Calculation
For a clearer understanding of the three points, I have calculated the average FD, CPI, and RRoR for each decade. You will notice the significant drop in both the average FD rate and RRoR over the decades.
|Years||Avg FD Rate||Avg CPI Rate||Avg RRoR|
|1981 – 1989||7.70%||3.30%||4.40%|
|1990 – 1999||6.89%||3.72%||3.17%|
|2000 – 2009||3.70%||2.18%||1.52%|
|2010 – 2018||3.16%||2.29%||0.87%|
This simply means, during the 80s and 90s investors can simply park their money in one of the safest investment instruments (FD) and expect an average return of 6% to 8%. However, from the 2000s onwards the average FD rate has dropped below 4%. To make matters worse the average RRoR is currently below 1%.
Could this be a reason, knowingly or unknowingly why the current generation is seeking riskier investments? I’ll let you decide.
Sometimes I wonder if this is one of the reasons why I as an IT graduate “poyo” about finance. I feel the financial system itself is pushing us towards risky investments, in some cases into scams too and most of us are not ready for it.
If you own a mortgage/housing loan, you tend to be happy every time BNM lowers the interest rate. But what if you are a retiree and your only source of income is from FD investment? Will you be happy then? I doubt it.
I have around 20 years more before I hit my retirement. Looking at the trend, the FD rate is always dropping. Will the rate be 0% during my retirement days? (This is not farfetched since the interest rate in both Japan and Europe is currently in negative territory.)
If the FD rate is 0% or worse in negative territory, what options will I have then? Remember, I’m a retiree and seeking for stress-free investment. Going through the volatile nature of the stock market may no longer be an option for me. Or will that be the only viable option?
I honestly don’t know. All I know is that instead of constantly worrying about the future, I should concentrate more on upscaling my current earning ability. Having said that, I believe it is in our interest to keep an eye on the interest rate movement. I’ll end this post with the below quote from one of the articles in The Athletic.
“There is a danger of thinking you know what is going to happen. You have to treat it as awareness of what might happen, rather than knowledge of what will happen.”A Premier League referee
A part-time Malaysian blogger writing his thoughts online. Interest in both personal finance and economics, mainly the behavior aspect of them. I consider myself Poyo since I do not have any significant credentials in both fields, so readers beware. Thanks for reading.