Low Interest, High Share Prices. What to Do?

Now that the Bank of Israel has lowered local lending rates again, to 4%, it's time to admit the truth: we live in a world of low interest rates and depressing returns on investments.

How depressing? Well, if you went to the bank today and asked to deposit money in a shekel deposit, you'll get maybe 2-3% a year, at most. If you're more sophisticated and know that the bank will always give lower interest than do makams (treasury notes issued by the Bank of Israel), then you'll get rates of 3.7-3.9%.

If you're willing to risk a little more and buy long-term bonds, you still won't hit pay-dirt. Ten-year fixed-income Shahars offer 5.2% a year while long-term linked paper is giving just 3.3%, and that's with inflation flat as a pancake.

And these aren't even the returns in net terms. You have to deduct income tax on you capital gains. The result is pretty dire, especially for a public that had become used to returns of 6-7% on short-term investments, and double-digit returns on longer-term ones.

But that's the reality. Despite Israel's powerful economic growth and roughly-zero inflation here and in the world, the Bank of Israel was forced to lower interest rates in order to try to restore inflation to the target range of 1% to 3%. It hopes the rate cut will finally weaken the shekel against the dollar, but it may not. The shekel may will maintain its strength and inflation will remain low, which means interest rates could drop some more this year. What can a saver do, if 2% to 4% doesn't do it for you?

One solution is to invest in stocks. That's become more popular than ever before. Low interest rates is one of the main reasons why Tel Aviv's leading indexes passed the 1,000-point mark.

But the stock market is a risky business. Gains come, and vanish. If you get in at the wrong time, you might never regain your losses.

Some look abroad. There are no free lunches there either, but there are some countries offering higher interest rates.

Take the USD. After the Monday rate cut, the interest rate gap between the dollar and shekel widened to 1.25%, which means interest of more than 5% on a dollar deposit compared with 4% on a shekel deposit.

Say you fear that the dollar will weaken further because of rising expectations of recession in America. There are other ideas. A deposit in British  pounds will deliver 5.4% a year, and a short-term deposit in the Australian dollar will bring in more than 6%.

You can alternatively do what millions of Japanese have been doing in the last year: unhappy with the quarter-percent at home, they're haring for New Zealand, where interest is running at 7%.

Aware of the situation here, foreign banks have been sending representatives to Israeli institutional investors, offering investments overseas. Some of the instruments they suggest are pretty complex, but what our investment managers want is something pretty simple: medium-grade corporate bonds (between A to BB). A diversified portfolio of medium-grade corporate bonds could generate a nice 7% a year in dollar terms. You are likely to find that in a few months, your insurance company or pension fund sharply increased its investments outside Israel.

When interest rates are low, the usual remedy is to seek solutions elsewhere in the world. It's a good strategy, history shows, but it is not risk-free. The currency you choose could crash, or the company whose bonds you bought could collapse, in which case 2% on a deposit will suddenly look mighty sweet.