This article first appeared in the August 25th edition of Robert Powell?s MarketWatch blog. It reappears here with Mr. Powell?s permission.
BOSTON (MarketWatch) ? Interest rates are down and inflation is up. For retirees who depend on interest income from their fixed-income investments to pay living expenses, these are rock-and-a-hard-place times.
The yield on the 10-year U.S. Treasury note is about 2%, or one-half its yield in February. The yield on the two-year note is 0.22%, about two-thirds its yield at the beginning of 2011. Meanwhile, inflation has risen 3.63% over the 12 months ending July 2011.
With millions out of work, many people have been forced to take a break from contributing to their retirement account. But once they start saving again, how can they get back on track? Here are some tips.
Let?s put this in perspective. If in February you had a $500,000 portfolio of 10-year U.S. Treasury notes throwing off $20,000 in income to fund your living expenses, and for some reason you had to reinvest all that money in the 10-year notes being issued today, your portfolio would generate only $10,000 in interest income. Meanwhile, the cost of goods and services that your $20,000 in interest income once paid for has now risen to $20,600.
In other words, to maintain the very same standard of living you need to generate another $10,600 in interest income ? which is impossible to do without taking on more risk ? and/or start dipping into your principal, which could put your living standard in jeopardy later in life. Or you might consider reducing your standard of living today and wait for interest rates to rise again.
What?s a retiree to do?
Identify, prioritize your risks
Among the items high on your to-do list: Get a handle on the risks you will face in retirement ? be they longevity, inflation, interest rates, and/or the stock market. Next, determine which of those risks will have the greatest impact on your retirement, and then develop a plan to deal with it or them.
Doing this on the fly, while you?re in a state of duress, isn?t ideal but it?s better than making rash decisions and chasing yields only to expose yourself to another risk for which you are unprepared. If you already have a strategy in place, now would be the time to revisit what, if any, changes you might want to make to your plan. Planning for interest-rate risk is one thing; living through it with real money at risk is a whole nother story.
Revisit your expenses
We often think of fixed expenses in retirement as being just that ? fixed. But experts, including Dan Weinberger, a vice president of retirement product strategy and behavioral finance at MetLife, suggests that retirees should use this low-interest-rate environment to revisit their fixed and discretionary expenses.
?It?s tough. People will be faced with hard decisions,? Weinberger said. ??People don?t want to compromise on essential expenses. People aren?t afraid of making compromises on wants ? but not on needs.?
It might be that you can cut some expenses that are more ?wants? than ?needs,? and thus reduce the need to make up lost interest income. ?Now is a good time to figure out what?s essential and what?s not,? said Craig Lemoine, CFP, an assistant professor of financial planning at The American College.
Lemoine noted that the low interest rate environment is a double-edged sword: Interest rates on investments are low but so, too, are rates on loans. ?Now would also be a good time to take advantage of opportunities to refinance your mortgage or unsecured debt,? Lemoine said.
Now might be a good time to consider a reverse mortgage, Weinberger said. The reverse mortgage, even if you don?t use it right away, would have a low interest rate and could be a source of much-needed money to pay for living expenses at some point.
For his part, Dan Keady, director of financial planning for TIAA-CREF, recommends a two-part strategy for retirees looking to generate income. First, retirees ought to determine their monthly income needs for the basics ? food, housing, and the like ? and see how much of that Social Security and existing pensions will cover. Second, retirees should consider ?annuitizing enough of [their] savings to create a guaranteed income floor to take care of those basic expenses,? Keady said. (More about annuities in a bit.)
Trade safety of principal for higher yield
For those who have a handle on the risks they will face in retirement and who don?t mind trading safety of principal for a higher yield, there are a number of options to consider, including corporate-bond funds, floating-rate funds, preferred-securities funds, and maybe even equity-linked CDs, junk-bond funds, and the like.
?It?s an incredibly challenging time for retirees,? said Anne Lester, managing director and portfolio manager of the JPMorgan Income Builder fund (MFD:JNBAX) and portfolio manager of JPMorgan?s SmartRetirement target-date funds. ?It?s one of the consequences of a low-interest-rate environment that you cannot get the same sort of income without taking on more risk.?
The questions become these: What kind of risk are you willing to take? How can you look across the investments available and come up with something that provides diversification and the highest-adjusted yield or return? ?It?s not just cash or CDs or bonds,? she said. ?You might have to think about equities or other parts of the capital structure.?
To be sure, swapping CDs for other types of investments might prove a bumpier ride, but it might also address the risk of inflation ? a risk that CDs don?t quite address. For instance, the JPMorgan Income Builder fund has a current yield of 5%, but the ride was hairy in 2007 and 2008. The fund fell 25.5% in 2008 and then rose 39.5% in 2009. (The ride has been much smoother over the past three years, however. It?s gained on average 6.76% per year for the three years ended Aug. 23.)
Or consider the Principal Preferred Securities fund (MFD:PPSAX) , which is the first and largest open-ended fund sold in the U.S. that focuses solely on preferred securities. The fund has a current yield of 5.61%, but you?ve got to be able to weather the roller-coaster years such as 2007 through 2009; it lost 8.3% in 2007 and 22.4% in 2008, and gained 46.2% in 2009.
For his part, Keady said that TIAA-CREF suggests that retirees, after matching fixed sources of income with basic living expenses, invest any remaining assets in a diversified portfolio including stocks, bonds and other investments, from which they can systematically draw money to cover discretionary expenses. ?In a diversified portfolio you?re investing for total return and would have the potential to draw against that growing principal, which can provide the potential for rising income over time,? he said.
Try product allocation
When swapping safety of principal for yield, retirees should consider adding not only capital-market solutions but other types of solutions as well, including insured products such as annuities. In the parlance of those in the business, it?s called product allocation, and it includes investing in a mix of assets such as stocks, bonds, cash and insured products, such as variable annuities with guarantees and single-premium income annuities. Read: How to create your own pension plan.
The question, according to Weinberger, is this: What do you need to invest in to generate the most income at a level of risk that you are comfortable with? ?No one wants to take a pay cut,? he said.
But to get the most out of what you have, you may have to be willing to give up control of some savings in return for a higher interest rate. Translation: annuity. According to one MetLife example, a 65-year-old man could invest today $100,000 in a single-premium immediate annuity (lifetime income with 10 years guaranteed) and receive annual income of $6,850. True, that person would give up some control of the money, but they would also generate more than three times the current yield of a 10-year Treasury note.
In reality, if you plan on taking this approach, you would likely invest in a variety of annuities, including fixed and variable with guarantees, along with other types of income-producing assets to make up the lost income from your low-yielding CDs and Treasurys.
In addition, you would invest in such products over time, not all at once, and diversify among different providers. ?In this low-interest-rate environment, some of our [401(k)] participants are asking whether they should annuitize now or wait until rates rise,? said TIAA-CREF?s Keady.
?We counsel that no one knows where interest rates are going. When you build your income floor, we suggest annuitizing over time. You can annuitize part of your assets this year, part next year and so forth to create a ?ladder? of interest rates.?
Other options?
If you are retired, and assuming that you?ve cut expenses as much as possible and put as much money at risk as you?re willing to, consider getting a part-time job. Or, if you?re semi-retired, consider upping the number of hours you work. It?s not ideal, but ? combined with the other tactics ? it just might be enough income to make up the difference.
All in, it?s possible to make up the interest income lost when interest rates fall and inflation rises. But it can?t be done without an investment of another sort: Your time and energy.
Visit our website to see how AgeBander Retirement Planning Software can help you prepare for retirement.
Advertisement
Like this:
Be the first to like this post.
atm funny facebook status texas a m football oec oec jamiroquai jamiroquai
No comments:
Post a Comment