20 July 2018

Rising Interest Rates Give Retirees Good And Bad News

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Say goodbye to a decade of rock-bottom interest rates — and if you’re a retiree or soon-to-be retiree looking for investment income, that’s good news.

But higher rates can also be a double-edged sword. If you have debt, if you have an adjustable-rate mortgage that’s about to reset, higher rates could sock you right in the wallet.

Here’s the background: the Federal Reserve has raised what’s known as the “Federal Funds” rate for the second time this year, and signaled that more hikes are coming in the second half of 2018. Banks and credit unions typically tie those rates to rates they offer you on things like savings accounts and certificates of deposit (CDs) — so a hike by the Fed typically means good news for savers.

“This has been a long time coming,” says Rob Williams, Denver-based director of income planning for Charles Schwab SCHW, -0.51%  . “Finally we’re seeing the (Fed’s) short-term interest rate rise, which has been very helpful in increasing the return on cash and short-term investments. It’s a great thing for retirees to be finally getting some return on their lower risk investments.”

One-year CDs, for example, are now yielding around 2.3%. Hardly spectacular, but consider what they were paying just three years ago: a minuscule 0.25% or so. Keep in mind though, that inflation is also rising, and rising prices can cut into your purchasing power and erode your standard of living. That’s why Williams calls these higher returns on CDs, money market and savings accounts “ballast” — they offer liquidity, stability and will help keep you afloat, but not much more than that.

The need for cash flow forced many Americans to take added risks during the low-rate era. Williams says you may want to consider dialing back that risk now.

“At this point, with interest rates rising, it behooves a lot of retirees to look at the risks they’ve taken and making sure that they’re holding investments they’ll be comfortable with — especially if we’re at the peak end of this economic cycle,” he advises.

This suggests reducing your stockholdings, particularly amid concerns that equities, which have made a huge run since 2009, may be due for a pullback — perhaps even a sharp one. (Williams is careful to note that he’s not making any predictions about the market’s direction.)

But here’s where things get tricky. We’ve suffered through two monstrous stock market collapses in just a generation: between 2000-2002 and 2007-2009. Folks in their 50s or 60s who loaded up on stocks just before those crashes saw their retirement dreams delayed, if not destroyed. After all, the older you get, the less time there is to recover from a market wipeout.

And yet, if you’re looking at 20, even 30 years in retirement, you’ve got to have exposure to stocks, because traditionally they’ve offered the best long-term opportunity to stay ahead of inflation. The government’s consumer-price index (CPI) might be low right now, running about 2% a year. But even 2% inflation over two decades will slash your purchasing power by a third.

On top of that, the cost of some big ticket items — like health care and housing — are growing faster than that. So here’s the dilemma: How do you generate the kind of cash you need, without having too much exposure to stocks?

There’s no one-size-fits-all answer here, Williams advises. Your age, your personal situation, your tolerance for risk makes you unique — talk it over with an adviser. But he does offer one bit of advice: Don’t overlook municipal bonds. The new tax law might have made munis somewhat less attractive relative to other opportunities, “but they are still very attractive for investors who are above the 10-15% tax bracket.”

Tune out the media’s focus on municipals that are outliers in terms of risk — Puerto Rico and Illinois, for example — and look at the overall health of the muni market. “There are 20,000 or more issuers in the municipal market and the credit quality and ability to pay for the vast majority is still quite high.”

Click here for the original article from Market Watch.

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