Low interest rates are bad for households with assets, but good for households with liabilities (loans).
For example, I was able to recently refinance my mortgage. So although the asset part of the balance sheet isn’t expected to do so well, I at least have a pretty sweet interest rate on my mortgage.
The balance sheets of retirees are dominated by assets, however. And while debt is on the rise among retirees, it’s the assets that fund retirement.
This suggests bond investors are going to have less money 10 years from now, in today’s dollars, than they do today. Plus, this doesn’t even factor taxes and fees, which will make things even worse (call it at least a -1% real return over the period).
Not exactly exciting prospects.
I’ve done quite a bit of research on the implications of low bond yields (and likely low equity returns) with Michael Finke and Wade Pfau. As a result, I think it’s always important to remind advisors, retirees and pretty much anyone who will listen that most research on optimal retirement income strategies has been based on historical U.S. returns, and the historical yield on bonds has been way higher than it is now.
The average yield on 10-year government bonds going back to January 1870 is around 4.5%. If we start in 1926, which is when the Ibbotson SBBI dataset begins (a common dataset among academics) it’s slightly higher at around 4.9%.
That means the current yield on government bonds is about 4% lower than the historical long-term average. Tack on investment fees, which used to be significant (at least 1% of assets), which lots of studies and advisors ignore, and you’ve got a very different investing environment today than we’ve seen historically.
Despite this fact, many financial advisors are still using historical long-term average values in financial plans. I think that’s beyond lazy, it’s almost malfeasance.
While I get it’s impossible to know what future returns are going to be (if I knew I sure wouldn’t be telling you!), they need to be reasonable — since these calculations form the basis of savings, retirement age and other expectations. In other words, I don’t think implicitly assuming 10-year government bonds yield ~4.5% (the long-term historical average) is reasonable.
When I wrote some of the original research on the impact of low yields on retirement, I remember some advisors (and reporters) complaining that the research was capturing a short-term anomaly and that low rates wouldn’t stay low for long.
Here’s the thing, though, interest rates are lower today than they were back then when we did the research. That begs the question: How low will rates go (and how long will they stay there)?