Why lowering interest rates to 0% doesn't work

Zero interest rates is perhaps the most important issue that faces us. In the past month, 10-year bond yields in Germany, the UK, Switzerland, France, Denmark and Sweden have fallen to historic lows.

The US 10-year treasury note has fallen to a new all-time low yield below 1.4%. Japan's 20-year bond yield has fallen below zero for the first time. There is now $US11 trillion ($14 trillion) invested globally at negative returns.

Low or no interest rates threaten to become one of the biggest investment issues we will have to handle over the next decade, an issue that is being largely ignored because it will only manifest slowly. In Australia we are somewhat nonchalant about the issue because our rates are still high by global standards.

In a global, long-term context, whether our interest rates are 1.5% or zero is largely immaterial. As inflation is 1%-2%, real returns are already zero.

The main issue is that we have some deep-rooted expectations that may be wrong about low interest rates, and we are conditioned to much higher returns than we are likely to see in the future.

As inflation has fallen and as the Western world has fallen into money printing (US, Europe, Japan) we appear to have reached an inflection point where the traditional tool of the central banks, lower interest rates, no longer stimulates spending by business and consumers and has instead started to inject fear rather than confidence and to promote saving rather than spending.

Low or negative interest rates are doing the opposite of what was expected of them because, if growth is muted and risk-free returns are much lower, it will be that much harder to grow your capital and you will need that much more money to retire comfortably.

No more will $1 million generate $100,000 each year without eating into the capital. In a low-interest rate, low-growth environment, capital becomes king because it is hard to find growth. No wonder people are saving, not spending.

How this manifests itself for us and our clients is quite clear. The returns from the averages - the average return on bonds, term deposits, property and the stockmarket index - will very likely be in the 0% to 5% range if not negative, even sharply negative if we wake up to it suddenly, because zero interest rates imply no growth and it would turn every assumption on its head.

Imagine if the biggest assumption of all, the assumption on which every balanced fund is based, the premise that has underwritten the illusion of value-add of every average-attaining financial product and adviser in the world, was wrong. That the market doesn't go up.

The world will migrate away from risky assets to safe asset classes.

The process has already started. The market fell 2.5% last financial year and real estate investment trusts went up 18%. If the average return doesn't deliver, and doesn't deliver with higher risk, then we all have to do something else.

The only way to beat those averages will be by picking stocks that can grow and individual properties that can be improved.

And the job of financial services will be to identify those investments consistently, with vigilance and discipline.

Anyone who doesn't change - to dismiss the average as not good enough, to add value for clients, to abandon sell-and-forget - will become a relic. Their businesses will fade away.

What you have to do is add value yourself, or identify the financial advisers and fund managers that can do this job for you. They're easy to spot - just ask them what investment they last bought, and why. If they can't answer, then you know who you're dealing with.

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