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What Negative Interest Rates Actually Mean for Investors

By Jordan Wathen and Gaby Lapera - Mar 13, 2016 at 11:31AM

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Some bonds are yielding less than 0%. Here’s why this once-thought-impossible idea is becoming reality.

In many major economies around the world, interest rates are now negative. Thus, investors are choosing to lose money by lending money to German, Japanese, and the Swiss governments.

Here's why low rates are creating a run on the bank for big bank notes, and why some investors are willing to accept a negative return on their investments. In this week's Industry Focus: Financials, The Motley Fool's Gaby Lapera and Jordan Wathen tackle the not-so-theoretical reality of negative interest rates.

A transcript follows the video.

This podcast was recorded on March 7, 2016. 

Gaby Lapera: We had another listener write in and ask about negative interest rates, which actually coincides with some articles I've been editing. So, negative interest rates, what are they?

Jordan Wathen: Negative interest rates, probably the scariest thing in the world, right? Imagine the idea that you give someone -- you loan someone money under the promise that they're going to pay you back less in the future. So, let's say, Gaby, that you're such a good credit, and I'm so worried about the global economy that I'm going to loan you $10,000 under the promise that you're going to pay me, say, $9,500 back in the future.

Lapera: Yeah. And the idea is that I will definitely pay you back. But, you're right, this is something that's never been seen before in financial history. Up until a couple decades ago, this whole concept was theoretical.

Wathen: Right, and it's still kind of theoretical. If you go to the curriculum to become a chartered financial analyst, the curriculum basically says, "Oh, negative interest rates can't happen, so don't worry about it." And this is a designation that's super highly respected on Wall Street, probably 50% of bond fund managers out there have one, and they've all studied under this premise that negative interest rates simply don't happen -- it's something that's just theoretical, it's an idea. And now, of course, it's a reality in a lot of places around the world.

Lapera: Well, as of right now, three major economies have negative interest rates, which are Japan, Switzerland, and Sweden. 

Wathen: Right.

Lapera: You're right, it's a reality now. So, part of the reason people thought that negative interest rates were completely theoretical is because, say you have your money in a bank, and you have that tiny interest portion back every month, right? Right now you do, and right now, it's super low. But when you have negative interest rates, you actually have to pay the bank to hold on to your money. So, everyone thought, negative interest rates will never happen because people will just withdraw their money from the bank and leave.

Wathen: Right, exactly. And there's a lot of talk now, especially around the world, people are talking about, they need to print more big dollar denomination bank notes because people are just sitting on them. Because, when your option is to go loan money to the German government for 10 years and get less back, it's preferable to just keep the cash hidden underneath the mattress.

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