Rising Interest Rates means opportunity for retirees. Our experts share their thoughts on how to make the best of these changes.
Interest rates got you down? They’re on the rise and this means new opportunities. We asked experts from the National Association of Personal Financial Advisors (NAPFA) for their thoughts on what the increase in interest rates mean for Americans, especially retirees. Here’s what they had to say about what’s happening and how you can make the best of these changes:
Deva Panambur, CFA®, CFP®, NAPFA Board Treasurer/Secretary and Managing Director – Sarsi, LLC
Interest rates had been kept artificially low for over a decade and it was only a matter of time before it rose. While the recent increase in interest rates has been quite dramatic, you can argue that it is now at more normal levels.
Inflation is currently at historically high levels and are expected to decline in the months ahead but if they normalize at a higher level than in the previous decade, you can expect interest rates to remain high.
The good news is that for the first time in many years, cash, cash equivalents and bonds are attractive. For investors at a high tax bracket, municipal bonds are very attractive on a tax equivalent basis.
The simultaneous decline in stocks and bonds has been painful for investors but drives home the need to have a balanced portfolio and to have cash for near term expenses especially for retirees.
What you can do:
Ensure that your cash reserve is earning a decent return- bank accounts are yielding close to 0% interest- you can get a better rate in certain certificates of deposits (including no-penalty ones that allow you to redeem at any time without penalties) and money market funds.
You can also invest $10,000 per person or entity such as an LLC (and an additional $5,000 using your tax refund) in I-Savings bonds offered by the US Treasury. The interest rate on the I-Savings bonds is based on the Consumer Price Index data and is currently yielding a very attractive rate. You cannot redeem your investment for one year and you lose 3 months interest if redeemed between year 2 through 5.
Review your portfolio allocation to make sure that it is balanced and in line with your risk profile. If you have a significant amount of money in target date funds- you should review the allocation to make sure that it is suitable for you. The asset allocation in a target date fund is based on only one input – your retirement year and it turns out to be too conservative for near retirees especially if you have other sources of income and you do not expect to use your retirement investment for your living expenses.
Any changes you make to your portfolio should be executed in a planned gradual manner and not all at once.
If you have cash lying in the sidelines- this is a good time to leg into stocks and bonds. The best approach is to create a well-balanced portfolio. If you invest in dividend paying stocks keep in mind that they still have equity risk ie they could suffer capital loss when the market declines. Also do not pick dividend paying stocks based only on the dividend yield- a high dividend yield could be a signal of trouble in the company. Ideally, you want to invest in stable companies of different sizes that also pay a dividend.
If you have any liabilities with a variable rate such as credit card debts, you will want to pay those off to avoid having to pay a high interest.
If you withdraw money from your investment account using a flexible approach you will want to re-evaluate your withdrawal based on your current investment balance and any guardrails you may have specified.
Dr. Joseph Goetz, Ph.D., M.S., M.A., CRC®, AFC®, Founding Partner & CIO – Elwood & Goetz and NAPFA Associate
Seasoned investors understand that to be successful investing must be viewed as a probabilistic science within the context of time horizon. Over time, there will be periods of low and high interest rates. There are pros and cons to both. Although higher rates have the potential to slow economic growth, they also have the potential to increase probabilities of success with investing. Think about the conventionally recommended sustainable withdrawal rate of 4% over 30 years in retirement. Obviously if one- and two-year Treasuries are providing an essentially riskless rate of turn of over 4% (like they are today), retirees can substantially reduce the standard deviations of their portfolios, at least over the short-term. For those with a lower risk tolerance, this is particularly helpful.
What you can do:
With higher interest rates for the first time in a long time, government bonds (I-bonds, Treasuries, etc.) and corporate bonds can provide the yields that many people need to meet their goals without having to stomach the more extreme ups and downs of the equity markets. CDs and online savings accounts will provide greater returns on consumers’ cash reserves and emergency funds, which can make a big difference over time.
Remember, the primary purpose of bonds in a diversified portfolio is to reduce downside risk and to provide for rebalancing and buying opportunities when various asset classes of stock plummet. Well, going forward, at least in the offing, retirees will likely make good money on the fixed-income side of their portfolios (with a lot less risk). For most, making money on bonds is a lot more comfortable than stocks because of the lower standard deviation.
Since before the Great Recession of 2008-09, short and intermediate-term U.S. government bond yields are at their highest levels. Now this year will likely go down as being one of the worst in history for bonds, but that’s mostly a sunk cost at this point. Over the past months we’ve seen billions of outflows from bonds (and big negative returns) but going forward, bonds will become much more attractive. In the short term, we could see further price declines assuming the Fed continues to raise rates. Not even the Fed really knows what they are going to do a few months from now, but we’re all likely to benefit from these higher treasury rates for some time. In just one year the 1-year treasuries have gone from 8 basis points to over 400 (i.e., .08% to >4%)! Going forward, we will likely see even greater benefits.
Remember, there’s a lot of short-term pain with rising rates, but it sets us up for a better future. Retirees will yield higher interest on safer investments, and the Fed will have an important tool in their toolbelt that they haven’t held for a while – the option and ability to substantially lower rates to stimulate the economy when needed.