Don't Let Low Interest Rates Destroy Your Retirement


Photo: Flickr / ahisgett

Yields on most of today’s fixed-income investments are at or near historic lows.Money market funds are generating little if any return. Certificates of deposit aren’t doing too much better.

Even 10-year Treasury bonds are only yielding around 1.75%. A slow recovery, ongoing debt problems in Europe and uncertainty about future economic growth have sent many investors rushing to the safety of Treasury bonds, driving down yields.

And the problem isn’t going to get better anytime soon. In mid-September, the U.S. Federal Reserve Bank announced its latest round of “quantitative easing” or QE3. Designed to stimulate the economy, the move is expected to keep interest rates low through at least the middle of 2015.

This is a dangerous environment for those searching for sources of retirement income.

Low Rates Kill Retirement Income

Low interest rates are a problem for virtually all investors, but are particularly troublesome for retirees, who need their assets to generate income to supplement Social Security and private pensions to help pay for day-to-day living expenses.

This is just another obstacle facing Americans, who have already not saved enough, in assuring themselves a secure retirement.

According to the Employee Benefit Research Institute 2012 Retirement Confidence Survey, only 14% of workers say they are “very confident” that they have saved enough money to live comfortably in their retirement years.

While part of the problem is due to simply not setting aside enough money, the difficulties are compounded by the changing retirement landscape. A generation ago, our parents and grandparents depended on Social Security, a private pension and a small nest egg to pay for retirement.

Not so today.

According to an ING retirement survey, Retirement Across the Ages, only about 47% of those over age 65 are receiving payments from a traditional pension plan. For younger workers, that number drops significantly. And the promise of receiving a significant amount of money from Social Security weakens with each passing year.

That means that people who are retired today, or those who plan to retire soon, need the money they have accumulated in 401(k) plans, IRAs and private savings to work even harder for them. Otherwise, they risk not having enough assets to fund a retirement that could last for 20 to 30 years or more.

The Hunt for Retirement Income

All of this leaves retirees searching for income in an environment where yields above 1% or 2% are very difficult to find without making a long-term commitment. But there are alternatives.

Here are just a few options that retirees might consider.

Cut your expenses. This first suggestion is more about financial planning and less about the investments you select. But it deserves a mention. For some people, making the transition from your earning years to retirement is difficult. Theories vary about how much income you need in retirement but experts suggest that you plan to have 70% to 80% of your pre-retirement earnings. If you are healthy and planning to travel, that amount could be higher. If you are less healthy, that amount could still be higher due to increased medical expenses.

Either way, most people need to trim their expenses when they retire. If necessary, work with a financial counselor who can offer budgeting assistance and make suggestions on where you can cut back.

Remember, the lower your expenses, the less income you need and the less chance you will have to invade principal to help pay those expenses.

Widen your horizons. Simply put, you may need to take on more risk to generate the income you require.

While the traditional advice has always been that retirees cut their exposure to risk as they get older, that advice simply may not work in today’s historically low interest-rate environment. Rather, investors may need to be willing to take on more risk until such time as the interest rates on traditional retirement investments such as money market funds, certificates of deposit and government bonds return to more acceptable levels.

Stay diversified. Even if you are already retired and need a portfolio that generates income, it’s important that your investments still have an element of growth. If you are 68, for example, your retirement could last another 15 years or more. That means investing in stocks and other assets that have the potential to grow in value is important to make certain you don’t outlive your assets.
Related: To discover six great dividend stocks, Click here.

Consider other investments. Government and corporate bonds aren’t the only ways to generate income.

Here are some investment alternatives you should consider.

Immediate fixed annuity. Although interest rates are low and expenses can be high, purchasing an immediate annuity with a portion of your assets can be a good way to generate an income stream that you can’t outlive. While variable annuities may sound attractive, they aren’t generally a good investment for older investors because it takes too long to cover the expenses the insurance company charges.

Exchange-traded funds. Investors are increasingly turning to exchange-traded funds that specialize in dividend stocks to generate yield-and some growth. According to Martin Hutchinson, Global Investing Strategist for Money Morning, investors can use higher-yielding dividend stocks as a partial replacement for bonds. And, he says, “their dividend yield is just as reliable as a bond yield, and should increase with inflation and economic growth.”

Master limited partnerships. These trade like stocks and provide the equipment companies need to drill or transport oil and gas. Because the law requires them to pay out 90% of their income, a portion of which is tax-free, their high yield makes them a great retirement investment, although not in an IRA or retirement plan. But some companies have introduced master limited partnership mutual funds and ETFs that might work.

Alternative investments. Some alternative investments are a great way to generate income. These include managed futures, REITs that are not traded on exchanges and long/short funds, which use a strategy similar to hedge funds. But be careful, some of these investments are riskier than simple stocks, bonds and mutual funds. So look carefully before you invest.
It Won’t Last Forever

Creating retirement income today is more difficult than it has ever been. But the good news is that low interest rates on bonds, certificates of deposit and government securities won’t last forever.

Reevaluate your portfolio regularly as your goals and market conditions change.

Eventually, yields will go up again and it will be easier to find good sources of retirement income that you need to create a safe and secure future.

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