Actions, Pensions | If this prediction comes true, large sums will be lost

Historically, interest rates have been higher than today, in some cases significantly higher. What happens when interest rates drop to zero percent? Will return on equity also drop?

Yes, says Holberg Fondene, who believes that five percent in the stock market can become the new normal (see chart below).

– This has been the great discussion for the last almost ten years. We have observed that interest rates have continued to fall. Adjusted for rising prices, they have come close to zero and may be negative, investment director Tormod Vågenes at Holberg Forvaltning tells Nettavisen Økonomi.

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Affects the pension

A key question is whether large professional investors will continue to demand around 10 percent returns in the stock market, regardless of interest rates. Or do they accept 4-5 percentage points more than what they get in the fixed income market, even with the record level of low interest rates?

Then the expected return on the stock market will clearly fall, which can affect your pension payments.

– Surveys show that US pension funds still have a target of just over 7 percent in annual returns. It is completely impossible to achieve under current framework conditions. Pension funds must increase risk or lower expectations, says the chief investment officer.

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Watch out

We take the provisions of the Holberg Funds very seriously: your employer reserves you NOK 30,000 a year in pension contributions, 5.5 per cent of the average salary of NOK 550,000. The expected wage growth in the next few years is 3 percent.

The savings horizon is 30 years. If you are careful and put all the money in the bank, etc., you get only 1 percent, in the stock market you get 5 percent.

The differences will be extreme: Those who only save on interest will have a pension amount saved of NOK 1.63 million in 30 years. If, on the other hand, you are tough on the stock market and invest everything in stocks, you can expect 2.98 million. There is a difference of almost 1.4 million crowns, 140,000 per year over the ten-year pay period.

And if, contrary to expectations, it achieves 10 percent per year in the stock market, the final amount will be up to 7.08 million. That’s more than double the 5 percent option.

Deer

If pension funds are content with lower returns, companies must cover the difference with higher premium amounts in the old defined benefit plans. It can be costly, because employees are entitled to a guaranteed return.

But those who work in the private business sector now receive defined contribution schemes. The employer reserves an annual amount for you in pension payments, a minimum of 2 percent of your salary. However, YOU can influence the size of participation you want and can tolerate and therefore how much you get paid.

– Yes, it depends on the individual employee. There is a low participation in standardized models. In our opinion, the youngest workers who have between 20 and 30 years left to spend the money should have a very high participation.

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Significantly more

– A lower expected return and a low shareholding means you have to save a lot more money today, says Vågenes

Consumer economists have also been concerned about the issue: Younger employees, in particular, should increase their share of pension savings, otherwise they could lose hundreds of thousands.

An expected return on the stock market of 5 percent to 10 percent gives huge differences in your saved capital:

• If you deposit an amount of NOK 100,000 today and get a 10 percent annual return for the next 20 years, you have NOK 672,000 left before tax.
• If you only get a return of 5 per cent per annum, you must settle for 265,000 crowns, a difference of more than 400,000 crowns. But it is still much more than the alternative interest rate of 1 percent (122,000 crowns).

Whichever is the best

– The most important message is that regardless of the level of the interest rate in the end, the stock market will be the best option, says Vågenes.

The Holberg Funds examples are taken from the US market. As the chart shows, you can go as low as zero percent in returns on US government certificates, Government Loans with Short Maturities. “High Yield” are high risk corporate bonds. Over time, they will provide a return between interest and shares.

The average annual return on the stock market for the past 30 years has been around 10 percent, before costs. Stocks have averaged 4-5 percentage points in excess annual return versus bank savings and prudent fixed-income investments. It will be as the examples show a large amount of money of that type over time.

Petroleum Framework Background

Vågenes says they have also been talking here at home for many years about lower performance. The so-called Mork Committee, which among other things looked at how high the Petroleum Fund’s equity stake should be, assumed a long-term annual return on equity of 5.5 percent.

– But it is 4-5 percentage points better than what you get in the bank and in any case it is the best alternative, Vågenes repeats. And for those who save long-term in the stock market, it pays to live with short-term price fluctuations in the market.

Over time, the stock market will provide the highest return, but now interest rates have plummeted to zero. There they can stay.

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The last nail

– In recent years, both Norges Bank and the US Federal Reserve have reported an expectation of a gradual increase in interest rates. Covid 19 was the nail in the coffin, everyone capitulated, including central banks. Now everyone thinks that the interest rate will be low for a long time, it is difficult to see it rebound again, but we cannot rule it out, says Vågenes.

Chief Economist Jan Ludvig Andreassen of the Eika Group is perhaps the biggest interest rate pessimist, or optimist if you will, here at home. You think interest rates will probably never go up again.

– We are probably entering a world where interest rates will never rise again, at least no more than plus / minus 0.5 percentage points over the next thirty years. This reflects that there will be no economic growth, inflation or wage growth, Andreassen told Nettavisen in August.

Also read: The pension alarm sounds: many are surprised

Action bubbles?

– But if interest rates stay around 0 percent and many are chasing profits in the stock market, is there a danger of bubbles bursting in the stock market?

– It is a face of a persistently low level of interest rates. But it can be argued that investors are willing to pay a higher price for the shares by accepting a lower return. Now there is a lot of noise and the question is whether companies can achieve the required rate of return.

– If they are unsuccessful, and stock prices only continue to rise, it can create bubble trends in the short term. But we believe that the creation of value in the world will be positive in the long term, says Vågenes. And then stocks will outperform interest rates.