The Federal Reserve has caused quite a stir over the last few months with inconsistent messages regarding its time line for raising interest rates. In January, Michael Gapen, former Fed monetary policy division head, told USA Today that, “I think they’re in a wait-and-see mode, and they’re still sticking to their mid-2015 guidance.”
In mid-February, however, the Fed’s meeting minutes indicated that they might not raise rates until later in the year. “Nonetheless, a number of participants suggested that they would need to see further improvement in labor market conditions and data pointing to continued growth in real activity at a pace sufficient to support additional labor market gains before beginning policy normalization,” the minutes stated.
And finally, on March 18 the Fed issued a policy statement that it would indeed consider raising rates as early as June, albeit more gradually than officials first estimated. Current estimates put the federal funds rate at 0.625 percent for the end of 2015—still more than double the long-standing 0.25 percent but roughly half the 1.125 rate predicted in December.
Despite the uncertainty, it does seem safe to assume a hike will occur in the near future. “The Fed has kept interest rates the same since 2009, and at some point soon they’ll have to increase them,” said Kyle O’Dell, President of Secure Wealth Strategies. “The longer they wait, the greater the long-term risk to our economy.” The Fed has long waited for the job market to improve, but despite falling unemployment, labor force participation is still declining (Bureau of Labor Statistics) and real wages have barely risen since 2010 (Center for American Progress). In the meantime, asset bubbles have only grown larger.
What will a rate increase mean for current retirees? “Retirees in general ought to be more risk-averse, and a rate increase would only exasperate that need to shift money into safe money positions,” said Dan White, President of Daniel White and Associates. With a correction in site, few retirees will want to maintain significant holdings in an already volatile market.
Even a small rate hike could also bode poorly for seniors big on bonds. “Anyone with a big bond portfolio needs to know that as interest rates go up, you’ll have falling bond prices,” said O’Dell. Clients who still have a decade or more to work may have a shot at higher-yield bonds if the market normalizes before they retire, but current retirees shouldn’t bank on it. Over the next year, and particularly as the Fed begins to solidify its plans, retired clients will need to move some of that money into other securities to offset the price drop.
Fortunately, those other securities may see an uptick. “The interest rates you receive on that money in CDs and other fixed-type accounts are going to go up,” said O’Dell. “Raising interest rates is going to help us make money on our savings accounts.” Ultimately, clients who move money from bonds to CDs and high-yield savings accounts may actually improve their net worth and portfolio longevity.
As for seniors five to ten years out from retirement, a rate hike would likely affect them in similar ways – particularly in regards to their market holdings. “The most dangerous times to be in the market are still five years prior to and five years after retirement,” said White. “Because of the sequence of returns, you can’t afford to lose 25 to 30 percent in the first few years.” Conventional wisdom already says that seniors should move their money out of the market and into more secure assets, and in light of future stock devaluation, that advice is more sound than ever.
For middle-aged and younger clients, however, it may be best to just stay the course with market-based investments. “Sit tight and ride it out,” said White. “If you’re younger you can weather the storm. Nobody wants to see their 401(k) go backwards, but your dollar cost average is not going to hurt you as much.” A large loss that would devastate a current or soon-to-be retiree might even out in the long run, and younger investors have plenty of time to shift to other market sectors.
No matter clients’ age or shorter-term plans, they should keep in mind that once interest rise—and assuming the economy correspondingly improves—they’re not likely to fall back to our historic lows any time soon. “If we saw them go back to where we’re at now, I think it would mean we’ve fallen back into a recession,” said O’Dell. “All the way across, we want to see a slow uptick in interest rates until we get back to a more stabilized economy.” So, investors who have the means and desire to take advantage of our low rates will want to do so sooner than later.
Finally, the key to helping retirees and pre-retirees maintain their net worth during the rate hike is to help them focus on income, rather than asset allocation. “Most people don’t look hard enough at the downsides of their decisions, and for them, it’s all about getting that rate of return,” said White. “Retirement planning it not about the rate of return, though, it’s about sustaining an income stream over an unsure time line.”