Last week I received a message from my bank about the interest rate on my savings account. The bank announced that it would go down. Again. Since the credit crisis in 2008/2009, interest rates have been kept low by the European Central Bank to stimulate economic activity, and the interest rates on saving deposits are now very close to zero. The Triodos Bank even decreased the interest rate on their savings account to zero in March this year. Saving thus yields less and less. Many people complain about the low yield they receive on their money holdings, yet in 2015, still 60 percent of the Dutch public held all of their property on their savings accounts. An alternative for depositing your money is, of course, to hold an investment portfolio. The yields on investing can be certainly higher than the current yield on your savings account and if all people acted rationally, nobody would bother to save anymore.
Why is the interest rate on savings so low, what is the difference between saving and investing, and why don’t we all invest?
After the credit crisis, the European Central Bank (ECB) started a program called ‘quantitative easing’. This program is a special sort of monetary policy whereby the Central tries to prevent hyperinflation, while it is still stimulating the economy. The ECB bought bonds for a total amount of 60 billion euros to increase the money supply and therefore lower the interest rate. By lowering the interest rate, it is easier for banks to borrow from the ECB and other banks. This provided some stability and security, which was definitely needed after the credit crunch. Also, due to lower interest rates where banks can borrow for, there is less saving needed. Banks can finance the loans they issue by either private savings or loans from the ECB. The ‘asset purchase program’ carried out by the ECB led to economic growth and a lower interest rate.
The economic growth following from this program was derived from higher consumption (borrowing becomes more attractive) and higher investment (as saving becomes less attractive, people start looking for alternatives). Consumption in the Netherlands has increased by 1.6% in the first quarter of 2017 relative to the first quarter of 2016, and investment by 7.6%. According to these numbers, the monetary policy appears to be rather successful. Although investment has actually increased, still many people do not invest and hold all of their property on their savings account – which yields almost nothing.
Investing can take many forms. In the Netherlands, people invest mostly in houses (real estate), which is considered a safe investment. Due to the lower interest rate, mortgages have become more attractive and this has indeed led to more investment in fixed assets. Besides the fixed assets, people familiar with the stock exchange did increase their investment. However, the number of people that hold stock portfolios has roughly remained the same. It appears that investing in stocks is not that attractive to households as saving still is.
Holding stock portfolios is a way to earn money on your property that you would otherwise hold on your savings account. Many people think of investing as something quite difficult and sophisticated, but in fact, there are a lot of investment funds that do the thinking for you. Investing can thus be as difficult as you want it to be. You can start investing from €100 a month if you decide to put your money in a fund, and different investment profiles differ in riskiness. If you do not like risk, you can invest in a rather ‘safe’ and diversified portfolio with mostly stocks of established companies that have proven to make constant returns over time. Although the rate of return of a low-risk portfolio is not that high compared to the riskier portfolios, the yield is still higher than the yield on saving accounts.
Why don’t we all invest?
Given the low interest rate on savings and the ease of investing – or at least the fact that you do not really have to understand the stock exchange market yourself – it is strange that such a little amount of people in the Netherlands invests. In my opinion, there are three reasonable explanations for this phenomenon:
Risk aversion: people are not willing to take the risk of investment. Kahneman et al. (1991) discuss the concept of risk aversion, whereby they state that losses loom two times as big as gains. Due to this, many people try to avoid risk as much as possible, although it is often assumed that investors (and households) are risk neutral. The expectation that households would thus increase investments when the interest rate is low does not always hold. People may prefer a lower yield on savings to the possibility of a higher yield on investment, because the risk of ending up with less money than initially invested looms larger than the gains.
The status quo bias: in the same research paper, Kahneman et al. discuss the status quo bias. Due to this bias, people prefer the status quo to a new (but maybe more beneficial) option. The status quo bias arises from risk aversion, because new opportunities often come together with risk, disliked by people. Because investing is a new opportunity for many households in the Netherlands, investing does not appear to be really attractive. The fact that one could also lose money makes it even harder to switch from saving to investing. The decrease in interest rates could thus not lead to higher investments, because people prefer the status quo to investing. People do not always choose the best of all options.
Lack of money: another simple explanation for the fact that few households started to invest, is probably that they do not want, or are not able to spend money on a portfolio. For investing, you do need some extra money, because you cannot subtract your investments at any time once they have been made without selling the entire portfolio. The huge advantage of savings over investing is that you can get your money from your bank account whenever it suits you best. For investing, you therefore need a bit of extra money, which not every household has at hand.
All in all we could state that the lower interest rates that were caused by the quantitative easing program of the ECB have had the hoped effects, although the effects on investing are ambiguous. The lower interest makes saving less attractive, and increases the benefits of investing over saving. In fact, we do not really see this happening as such. Likely explanations of this almost ‘irrational behaviour’ are risk aversion, the status quo bias and a lack of available funds. But while the interest rate on my own savings account is getting lower and lower, I am considering investing in the stock exchange market more and more…