How Lower Interest Rates Affect Your Retirement
Lower interest rates create some obvious problems for retirees. Things like savings accounts and CD’s just aren’t earning much. But there is a longer-term problem with these low yields. Today, I’ll discuss how lower interest rates affect your retirement.
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For many, bonds are a significant part of your retirement nest egg. And, in my mind, there are three reasons to use them.
Reason 1: Less Volatility
Bonds reduce volatility. Think about what happened in March. The stock market fell over 30%. If you were 100% invested in equities, your account went down a lot! If you had 40% in bonds, the drop was much smaller.
Reason 2: A Place to Invest Your Future Income
Bonds give you a source of funds to generate your income. Selling stocks when they are down 35% to get your monthly check isn’t ideal. Putting your future income in bonds solves this problem.
Reason 3: A Way to Rebalance
Bonds give you a source of funds to buy stocks at better prices. Let’s say we get another big drop in the stock market in the next few months. I’m not saying we will, but if we do, you have a source of funds to buy stocks at those lower prices.
Lower Risk, Less Return
Owning bonds will reduce your future long-term returns. They just don’t generate the results stocks do. For example, the Vanguard Total Stock Market Index fund has averaged just over 9% per year over the past 15 years. The Vanguard Total Bond Market Index fund has averaged 4.3% over the same time frame. Adding more bonds reduces the impact of a bear market. But it also reduces your future returns.
Low Yields Translate to Lower Future Returns
Last week, we talked about lower expected returns for stocks and how that impacts your retirement. The current low yield environment also means we should expect lower future returns for bonds too.
In fact, Vanguard recently said we should expect bonds to generate returns of about 1-2% per year over the next decade.
So if we expect stock market returns of 6.5% and bond returns of 2% here’s what happens.
This is a real challenge when you need your savings to create income and grow to keep pace with inflation.
Lower interest rates and yields could have a major impact on your retirement plans. It’s worth having a conversation with a financial planner to see how it could affect you.
What do you think? Add your comments below!
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About the Author
Neal Watson is a Certified Financial Planner™ Professional and a Financial Advisor with Fleming Watson Financial Advisors. He specializes in helping hard working, middle class families plan for retirement.