The past few months have brought inflation, the Middle East conflict, upcoming midterm elections, and, most recently, surging government bond yields. Higher Treasury yields, offered to attract lenders, are also affecting other types of debt. Higher borrowing costs will also affect business loans and consumer debt, including mortgages, auto loans, student loans, and personal loans.
Rising interest rates can create hardships for just about everyone, but one segment of the population can benefit from higher yields: retirees. Most retirees do not have student loans, high-interest credit card debt, large auto loans, or high-interest mortgages.
A typical investment portfolio includes stocks, bonds, and cash instruments (CDs, money market funds). Stocks represent the growth portion of a portfolio – they increase in value on paper but generate minimal or no cash. Many stocks pay dividends at an approximate rate of 1%. Bonds and cash instruments pay interest based on the prevailing interest rates. Bonds typically pay interest semiannually, and cash instruments pay monthly, quarterly, or at maturity (i.e., a CD).
The “Growth and Income” option, when describing a portfolio, indicates that the portfolio includes both stocks and bonds. For example, a “60/40” portfolio would indicate 60% growth instruments, such as stocks, and 40% bonds/cash – income-generating assets.
Current Rates:
12-month Inflation Rate: 3.70%ᶟ
Money Market Fund: 3.77% (7-day yield)¹
CD Rates (3 months to 12 months): 4.25% to 4.65%²
U.S. Treasuries (1 yr): 4.52%
U.S. Treasuries (10 yr): 4.93%
¹Schwab® Prime Advantage Money Market Fund
²CDs offered through Schwab® Institutional
ᶟConsumer Price Index for All Urban Consumers (CPI-U): Bureau of Labor Statistics
A primary goal of any investment strategy is to outpace inflation. If inflation consistently outpaces your asset returns, you will lose purchasing power. This matters because inflation's biggest risk to retirees' after-tax income is the inability to keep up with living expenses, which can force a reduction in living standards. For example, 10 years ago, you spent an average of $800 a month on groceries. At a 3.0% inflation rate, those same groceries would cost $1,075 today. If your income did not rise by at least $275, you would need to withdraw more savings or reduce the amount or quality of purchases.
Lower interest rates may produce greater economic benefit for most people, but for retirees, they may reduce portfolio income and force older investors to take on more risk to earn the income they need.
During the accumulation phase of an individual's investment cycle, growth is the primary focus, as risk levels should be higher due to longer time horizons. However, once distributions begin, the focus for retirees shifts more toward the income aspect of portfolio management due to shorter time horizons, inflation, and tax issues.
Anthony B. Carr, CPA, CFP, is an independent Fiduciary with 26 years of experience managing client portfolios. Please visit our website or contact us by phone at (925) 484-1671 or by email to schedule a no-charge consultation to discuss your financial situation and how we can help.
