Low Interest Rates Mean You May Retire, but Your Money Can’t

Britain’s vote to leave the European Union will create some brand new problems, but for the time being it has exacerbated an existing problem – low interest rates.

Of course, you don’t often see the mainstream media describe low interest rates as a problem. Average Americans have been treated to record low mortgage rates in recent years. The country’s borrowing culture is such that cheaper credit is widely celebrated. The Federal Reserve has shown something approaching reverence about low interest rates, hesitating to disturb them from near-zero levels.

On the other hand, folks who have accumulated capital from building businesses or building retirement accounts find it more difficult than ever to generate much income from capital; the more capital one has, the more low interest rates can hurt. Net savers’ income falls when interest rates fall, and during the current economic cycle the impact has been quite devastating. It’s clear by now that this has not been a short-term phenomenon, and may not go away any time soon. The persistence of low interest rates has become something that changes the way people with capital need to invest, and even how they look at retirement.

Next to Nothing

In the two weeks following the Brexit vote, 5-year Treasury yields dropped by 28 basis points (about a quarter of 1 percent). That may not sound like much, but as low as Treasury yields were even before that vote, that change wiped out about 22 percent of the income on 5-year Treasuries.

Here’s the thing: a 22 percent drop in the stock market would make headlines and would be considered pretty punishing. Wipe out 22 percent of the income production from fixed income though, and it does not get much notice. However, in the long run that income loss may well be more devastating than a bear market in stocks for people who are primarily savers rather than stock investors.

After all, as damaging as the financial crisis was, the stock market has bounced back. Income yields, however, have not recovered, even though we are now seven years into an economic expansion. During the last recession, 5-year Treasury yields dropped by 78 basis points, an understandable response to a particularly rough economic environment. Since then, 5-year Treasury yields have dropped by another 154 basis points, to just 1.17 percent.

To put that in perspective, over the past 50 years the average 5-year Treasury yield was 6.2 percent. Yes, inflation was also higher for most of those 50 years, but inflation adjusted-yields still averaged 2.0 percent, versus just 0.17 percent today.

The point is that income generation has not just been crushed, but it has stayed down through both a recession and then a long (but tepid) expansion. Because this is not a short-term phenomenon, it changes the nature of investing.

No Retirement for Your Money

There used to be something of a parallel between retiring from a career and how an investment portfolio looked in retirement. Just as people cut back on their working hours and took it easy, asset allocations would slide into more passive, income-producing investments, such as higher dividend paying stocks or municipal bonds, to name just two of many such historic staples.

Not anymore. You may retire, but your portfolio cannot. Passive investing is one thing, but effectively generating little or no income doesn’t pay the bills, and many traditional income choices have simply become effectively unproductive. This means three things for investors:

  1. A broader investment palette. A traditional stock/bond/cash asset allocation is less appealing when bonds and cash are producing virtually no income, and public stocks may be largely propped up by low interest rates. Things like private equity and real estate might involve more risk, but better to take some calculated risks to be able to pay the bills. In this environment, you are either actively moving forward or generally drifting backward.  TIGER 21 Members have responded to that reality: over the course of the current economic expansion (2009 – 2015), their average allocation to fixed income has declined from 23 percent to 10 percent, with private equity and real estate allocations being the primary beneficiaries of that shift.

  2. More reliance on real estate income. In particular, real estate may deserve more emphasis these days because of the income production of certain types of real estate investments. Rather than searching for yield in junk bonds or riskier public stocks, diversified real estate holdings provide an alternative way to seek long-term income production.

  3. Greater alertness for opportunities. Retirement investing can no longer rely on a “set-it-and-forget-it” portfolio. Even in retirement, investors need to remain more active and more open-minded. TIGER 21’s peer-to-peer exchange has stimulated this kind of investing by providing a steady stream of ideas for Members. Not every investment approach discussed at TIGER 21 meetings is going to be your cup of tea, but the benefit is having a range of creative possibilities laid out before you so you can choose what suits your tastes and goals.

Creating wealth used to be the hard part, the greatest financial challenge. Retirement was supposed to be easy. Nowadays, retirement investing has become an equally if not more challenging undertaking. Firstly, the financial environment is so much more challenging, but secondly, successful entrepreneurs and professionals, who spent entire careers mastering a particular industry or profession, are being forced to learn an entirely new set of investing skills in hyperspeed, where the cost of failure can have significant consequences for the balance of one’s life.

The sustained low-income environment demands that investors remain highly engaged, even in retirement. For many of the TIGER 21 Members I speak with, these challenges can be engaging and filled with lots of exciting learning; however, these challenges still represent risks and levels of engagement that may not have been fully anticipated, and they are changing the nature of retirement.  That’s not necessarily a negative (and some are excited to meet these challenges), but it does require energy and discipline.  For better or worse, retirement investing is a lot more interesting than it was 20 years ago.

 

Barbara Goodstein Signature
Barbara Goodstein
President & CEO of TIGER 21 

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