Honestly, a lot of my friends (not to mention B) are sick of me bellyaching about low interest rates. But as many of you know, while low interest rates are a boon to 20-somethings who want to buy a house -- if only 20-somethings wanted to buy a house -- they make life difficult, and often poorer, for those of us who are retired.
Why? Because you can no longer go to the bank, deposit your savings in a CD, and get 5.0% interest, which might provide some decent income in retirement. Instead, you buy a CD (as I did last week) and you get 0.15% interest.
So, for my $5,000 CD I will receive $7.50 in interest for the year. Not a lot to live on.
But low interest rates don't just affect those of us who want to keep our retirement savings in a safe, secure, federally insured bank deposit. They mean less income for retirees who buy an annuity, less income for retirees who sign up for a reverse mortgage. And they certainly bring less income for people invested in bonds or a bond mutual fund . . . while exposing them to a lot of risk.
My problem is that I don't know what to do about it -- other than to bellyache. Or, as the Journal of Financial Planning says much more eloquently, "Turning [someone's] wealth that has been accumulated over a lifetime into a sustainable paycheck throughout retirement is one of the most important investment challenges for retirees . . . "
All I can say is, amen to that. Especially if you don't have a lot of wealth.
So I decided to turn to my friend, and financial guru, Jeremy Kisner of Surevest Wealth Management in Phoenix, AZ, to get some insight about interest rates. (He previously gave us some good info. on the question Is Long-Term-Care Insurance for You?).
He explains things quite well, and may even make us more financially secure:
Low interest rates have plagued fixed income investors for the past several years. Each year, analysts predict that rates will go up, and then ... they stay low or decline even further. Many consumers see this when they walk into a bank and are offered virtually zero interest on their savings and checking accounts.
Coincidentally, banks just announced near record quarterly profits. Apparently, charging 4.5% on loans and paying 0% on deposits is profitable. However, banks don't really set interest rates. Rates are set by the demand for Treasury bonds from investors (many of them from other countries) and somewhat influenced by the Federal Reserve. It seems that investors will continue to buy bonds regardless of their yield. See graph below:
If you think it is bad in the U. S., where the ten-year government bond is yielding around 2.4%, do not look over to Europe. Earlier this month, the yield on the ten-year German bond fell below 1.0%, and even economically challenged Spain borrows ten-year money at 2.1%.
You might be thinking, "Okay, interest rates are low, but what's your point?" I have a few:
1. There is real risk in the bond market. Prices move in the opposite direction of interest rates. This has been good for bond investors over the past 30 years, but is likely to go the other way sometime soon. It feels similar to the bubble that formed in residential real estate in the mid-2000s, which was overvalued for about three years before the market finally crashed.
2. Never design your investment plan looking in the rearview mirror. Many investors stick with a 40 - 60% allocation to U. S. government or investment grade corporate bonds just because that is what worked in the past. Today, you might want to diversify the bond portion of your portfolio by using other assets that have an equal or higher yield and also have the potential to appreciate. Some examples are: Real Estate Investment Trusts (average yield 3.25%); Oil and Gas Pipelines (ave. yield 6.0%); Covered Call Strategies (ave. yield 6.0%).
All these asset classes can be purchased easily through ETF's, which are fully liquid and trade just like stocks. However, some may present more complicated tax issues, and different risk profiles, so it's best to consult a financial adviser before jumping into these more sophisticated issues.
Finally, you can also think globally with your bond allocation -- not to Germany or Spain, but to emerging market debt which has an average yield of 4.4%. Are these markets more risky? Maybe. But many of these countries run budget surpluses, rather than deficits like the U. S., which suggests that they will gain economic strength as time goes on.
3. A retiree's income portfolio should always be designed with a total return objective -- as opposed to building it for yield with a "live off the interest and don't touch the principal" strategy. In other words, if someone has, say, a $1 million portfolio, and needs $50,000 per year, many people will buy bonds and other investments with yields of 5% or higher.
But this can be very dangerous, especially in these days of low interest rates, as many high-yielding investments can be more volatile. You are better off designing a portfolio where you expect a total return of 6 - 7%, but the yield from dividends and interest may only be 3%. This means that you will need to sell some investments and re-balance periodically. There will be years when your portfolio will decline in value and you will be using some of your principal. However, there will also be years when your returns are higher than your long-term average.
This may seem uncomfortable, but it is likely to give you a higher probability of not outliving your money. And if it makes you more comfortable, this strategy was validated once again by research published in this month's issue of the Journal of Financial Planning.
4. Your short-term emergency fund money still belongs in the bank -- regardless of any other decisions about your investments, or long-term plans for retirement income, and despite the low interest rates currently being offered. You don't want to incur any risk with the money you need to live on over the next few years. But long-term money should find a better place.