CRR: Retired households should favor return on capital

In a brief published this month, the Center for Retirement Research claims investors must choose between return of capital and return on capital, and further claims that retired households should favor return on capital. Because the market value of bonds can fluctuate, some households are inclined to believe cash and short-term deposits are safer, but the Center counters this view is too simplistic.

By investing in short-term deposits, a household is assured the full repayment of its investment when it reaches maturity, but is subject to reinvestment risk, according to the Center. Not only that, but inflation can makes the investment unreliable. On the other hand, long-term bonds are subject to inflation risk, but guarantee a fixed income.

“The ultimate objective of retirement saving is to finance consumption. The standard of living of a household that invests in short-term deposits is at risk if short-term interest rates fall. In contrast, changes in interest rates and bond prices may have no effect on the standard of living of a household investing in bonds.”