Are you feeling as frustrated as I am about the low interest rates available out there these days for those of us who are retired, wary of the global stock market and mostly living on a fixed income from safe investments? Five hundred thousand dollars invested down at your friendly local bank in a low-risk six-month CD at the current 0.8% rate will earn you only around $4,000 in interest — and that’s before taxes! Even with the low inflation rates – up around 2.2 percent over the last 12 months according the May, 2010 Bureau of Labor report – your purchasing power is losing ground, with modest interest returns being eaten up by the higher cost of living.
So where can an investor seeking a higher income rate try these days? It doesn’t look good anywhere in the usual places where you and I might traditionally invest some of our retirement portfolio and try to live off the interest income.
|Security Type||Current Return||Example|
|6-month CD||0.80%||Local bank|
|Money Market Fund||0.83%||$10,000 minimum|
|Short-Term Bond Mutual Fund||1.34%||Vanguard (VBISX)|
|GNMA Mutual Fund||2.97%||Vanguard (VFINX)|
|10-Year Treasury Bond Mutual Fund||2.34%||Vanguard (VFITX)|
|Long-Term Treasury Bond Mutual Fund||4.85%||Vanguard (VBLTX)|
Our Federal Reserve Bank has been pushing – and successfully keeping – short-term interest rates down close to zero for several years in their attempt to kick-start the U.S. economy and make low-cost capital available to the business sector as the economy recovers and the resulting expansion creates new jobs and businesses. That hasn’t happened yet but the huge budget deficits Uncle Sam is piling up will eventually force the Fed to raise rates in order to keep investors satisfied that the increasing risk of continued investment in US debt are appropriately compensated for by higher interest rates.
And what will happen to existing bond values when interest rates do start to rise? Old bonds will lose value and the longer the maturity of the bond involved – like the average 23-year maturity of the bonds held in the Vanguard long-term treasury mutual fund – the greater will be the decrease in market value!
Most of us have lived in an era of ever-decreasing interest rates. Since December 1980, the U.S. prime rate has more or less steadily declined for 30 years, from an all-time high back then of 21.5% to its current level of 3.25%. Most economists believe rates will have to rise soon; indeed Canada just last month made the first such move amongst the industrialized nations.
So what can a retired investor to do in search of higher income?
- Option One is to stay with the safety of short-term stuff like CDs and short-term bonds and just accept you are not getting any real return for your investment until interest rates move higher in the future.
- Option Two is to move out further on the risk curve and look for higher yields offered by riskier investments like junk bonds, master limited partnerships or un-hedged foreign bonds, seeking those mythical 5% return levels of yesteryear.
Which brings me back to those Russian bonds.
A few months ago, I wrote an article for this FPA web page titled “What Would Grandpa Do?” which was all about the investing adventures of my grandfather. Faced with his own coming of age in the first half of the 20th century, during a 50-year period that turned out to be witness to economic and social upheavals perhaps equal to our own time, Grandpa turned to Option Two. In 1916, during a time when U.S. Treasury bonds yielded around 2.5%, his banker (who was also his investment adviser) convinced him that bonds issued by the Russian Czar’s Imperial Treasury that boasted a coupon rate of 7.5% were as good as gold. So Granddad bought Russian bonds – about $10,000 worth. He got to clip exactly three of those high-yielding coupons before the October Revolution of 1917 hit and the new Bolshevik government defaulted on all the Czar’s capitalist obligations.
That default meant Grandpa’s Russian bonds were worthless! Today they are a lovely framed poster on my den wall; a curiosity and conversation piece. The moral of the story is that there is never any free lunch in investing. Risk and reward are irrevocably joined and if you take on too much risk, sometimes you lose. As the Stranger says to the Dude in The Big Lebowski: “Sometimes you eat the bear and sometimes the bear eats you.”
Me? I’m staying with Option One and just cutting back a bit on our discretionary expenses until this storm blows over. While nobody knows what the future will hold, as a retiree, I’d rather be safe than sorry!
Sam Hull, CFP®, ACC®, MBA
Business & Personal Life Coach
Riverbank Consultants, LLC