Interest Rates
July 2014
How low interest rates will affect your retirement
Today’s market environment has dramatically shifted from years past. The Federal Reserve, in an effort to stimulate the economy and reel it back from the depths of disaster after the 2008 financial collapse, has shifted interest rates to historically low levels. If you are a saver, or someone who does not like to take on risk, beyond investing in Treasury bills and notes and Certificates of Deposit (CDs), then you are well aware of the impact that low interest rates have on your income.
Unfortunately, the Federal Reserve has punished you for being a responsible saver over the last six years by devaluing the dollar. In doing so, the cost of food and energy has increased, while reducing your fixed income by 50%. To adjust to these consequences, you had to take additional risk by investing in asset classes such as corporate bonds (investment grade and high yield) or equities (stocks).
While the equity markets have done remarkably well since 2008, we have now entered into what some may call a bubble scenario. We have not had a correction of more than 10% in the equity markets which would infer an abnormal environment. While many economic indicators do not show signs of cracking, one must assume that there will come a point when there will be a significant correction.
With yields on Treasuries at 2.50% and conditions in the stock market becoming stretched, a person who is saving for retirement, or in retirement, should expect future returns to be less than the historical average.
“Compound interest is the eighth wonder of the world. He who understands it, earns it. He who doesn’t, pays it.”
That quote, by Albert Einstein, has garnered much attention in recent years. Consider a person who is saving for retirement; if your nest egg is $100,000 and you are earning a 4% return you would have approximately $180,000 in 15 years. If you would have earned 7%, you would have over $275,000 in 15 years, almost double the amount of earnings.
The idea of lower rates impacting your nest egg is obvious. However, what is the strategy for overcoming a lower rate environment? It can only be one thing, more savings. As an example, if you plan to retire in 20 years and you need $50,000 (in today’s dollars) of income in retirement, how much do you need at the end of 20 years, for 25 years of retirement living? First, you must adjust for inflation. Therefore, your $50,000 of income needs in actuality would be $90,300 (assuming a 3% inflation rate). Then, you will need that $90k for 25 years in retirement. If you are only returning 4% in retirement, adjusted for inflation, you will need approximately 2 million dollars in 20 years. If you were earning 7% instead of 4%, then your needs would be approximately $1.48 million. As you can see it means you must save much more than you initially planned for.
The harsh reality comes down to the fact that most Americans will need to save more and work longer in today’s monetary environment.
Michael Anicito, CFP®
Inspire Investment Solutions, LLC - President
The information above is a hypothetical example and is not representative of any specific situation. Your results will vary. The hypothetical rates of return used do not reflect the deduction of fees and charges inherent to investing.
Michael is an independent CERTIFIED FINANCIAL PLANNER™ who practices in New York and New Jersey. He works with individuals and business owners alike to help save for retirement and manage their assets. He is currently the President of Inspire Investment Solutions, LLC (www.inspireis.com). For more information or a complimentary consultation you can reach him at 646.606.2111 or at mike@inspireis.com. The scenarios presented are hypothetical and the rates of return used are not indicative of any actual investment, which will fluctuate and may lose value.
