Higher rates have created better income opportunities, but they haven’t eliminated retirement risk.
For months, much of the financial conversation centered on when the Federal Reserve would begin lowering interest rates. This past week, the Fed went the other direction, raising its benchmark rate by a quarter percentage point to 3.75%–4.00%.
Perhaps more important than the increase itself was the message about what may come next. Policymakers indicated that rates could remain higher for longer as the Fed continues trying to bring inflation under control.
For retirees and pre-retirees, there is good and bad in that story. Higher rates have made CDs, Treasury securities and other conservative investments more attractive. But a 5% Treasury yield today is not the same thing as guaranteed income for the next 25 or 30 years.
That distinction matters when you’re trying to build a retirement paycheck rather than simply choosing an investment that’s affected by economic, industrial and governmental changes beyond your control.
For years, retirees faced an uncomfortable problem: investments traditionally associated with safety produced very little income. Today, Treasury yields around 5%, attractive CDs and competitive money-market rates have finally given conservative investors meaningful income choices again.
Consider the difference. A $500,000 investment earning 5% generates $25,000 of annual interest before taxes. At 2%, the same amount generates only $10,000. That’s meaningful, but it doesn’t necessarily make retirement-income planning easier.
Suppose a recently retired couple has $1.5 million spread among IRAs, taxable investments and cash. They see 5% yields and reasonably wonder why they should continue taking much investment risk.
My first question for them would be: What job does this money need to perform?
Money needed over the next year or two should generally emphasize liquidity and stability. Today’s higher short-term rates can be very useful for that purpose. Money intended to support the couple at age 85 has a different job.
Imagine purchasing a five-year CD or Treasury at 5%. Five years later, the principal comes back, but suppose comparable investments then pay only 3%, making your purchasing power less while also fighting inflation. The 5% income stream disappears. Maintaining the same income may require spending more principal, accepting additional risk or reducing expenses.
That’s reinvestment risk. A temporary interest rate shouldn’t be mistaken for a permanent retirement paycheck.
Long-term bonds have another risk. Their prices can fluctuate significantly when interest rates move. Someone holding an individual Treasury to maturity may receive the promised principal, but a retiree who needs to sell early could experience a loss.
Continued in Part 2: Build the Paycheck Before Chasing the Yield
Information presented is believed to be current. It should not be viewed as personalized investment advice. All expressions of opinion reflect the judgment of the authors on the date of publication and may change in response to market conditions. You should consult with a professional advisor before implementing any strategies discussed. Different types of investments involve higher and lower levels of risk. There is no guarantee that a specific investment or strategy will be suitable or profitable for an investor’s portfolio. There are no assurances that a portfolio will match or exceed any particular benchmark.
Content should not be viewed as legal or tax advice. You should always consult an attorney or tax professional regarding your specific legal or tax situation. Estate planning is done in conjunction with your estate planning attorney, tax attorney, and/or CPA. Fusion Investment Advisors is not engaged in the practice of law or accounting.
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