In late 2015, the Federal Reserve raised interest rates, moving from the near-zero policy for the first time in almost a decade. With much speculation for rate changes to continue in 2016, attention is on the upcoming meeting slated for this month of the Federal Open Market Committee (FOMC) to identify if and when the next change will occur.
So, what are the implications for your retirement, both for:
- 1) Sustaining retirement with current low-interest rates and
- 2) Investment considerations for potential rate changes?
There was a time in which retirement planning was simpler; when you could stagger or ladder CDs at a bank and the interest would provide a sustainable income. In more recent years, you may even be paying the bank to hold your money with more fees than returns, (or at least it may feel like it). While a rate increase would result in more interest for savings accounts, these rate changes are expected to be a slow and gradual process, if and when they even occur. For this reason, along with more demands and complexities for today’s retirees, a comprehensive plan and a more modern approach to investment management has become more important than ever to reach and sustain retirement goals.
Bonds or fixed-income investments have largely been considered a staple investment for retirees. Recognized as generally more conservative than their equity counterpart, these investment vehicles are used more for their income yields than capital appreciation returns. This characteristic has traditionally appealed to the income needs and risk tolerance of a retiree. However, with interest rates near zero, competitive yields have been difficult to find without taking on either a long time commitment or lower credit quality entity. The time commitment (or duration) creates a particular concern as we enter a rising rate environment. Interest rates and bond prices have an inverse relationship, so when rates increase, the price of your bond will decrease. This may result in having to sell at a discount (less than your purchase price) if you need to get back your investment dollars before maturity. An additional risk consideration for fixed income in today’s interest rate environment is credit risk. Lower quality or “junk” bonds often pay a higher, more attractive yield, but in exchange for the consideration of an increased risk of default, or inability to pay you back your capital.
Negative Interest Rates
While it may seem rates can’t get much lower than they have been in recent years, the theory of negative interest rates has actually become a reality for other significant global banks in the past two years, including the European Central Bank and Bank of Japan. It may be an unlikely option, but an option none-the-less that the Federal Reserve may consider in the future. Federal Reserve chairwoman, Janet Yellen, has even acknowledged a review of the strategy, though stating in a congressional testimony earlier this year that it was not currently envisioned for the United States.
How to prepare?
The broad-reaching implications of interest rate changes may feel daunting and complicated, largely because it is beyond our individual control. So, what can you do? Perhaps the most essential ingredient to retirement success in a low and changing interest rate environment is a trusted and proactive financial professional with both a dynamic investment philosophy that can tackle evolving challenges and interest rate environments and the independence to access a variety of investment tools and vehicles to be able to adapt accordingly.
To discuss how to prepare your retirement plan for today’s interest rate environment, please give our office a call at (803) 547-7853 for our Charlotte office or (843) 757-9400 for our Hilton Head office.