NEW YORK (MainStreet) While abnormally low interest rates on bonds and other fixed income investments may help the overall economy, the long term effects could be disastrous for the millions of retirees and near-retirees who rely on interest earnings from bonds and bank CDs to support their retirement income needs.
"Retirees content to stay heavily invested in bonds may see their retirement savings shrink faster than expected," said Ken Nuss, founder and CEO of AnnuityAdvantage.com. "After all, who can say they're comfortable with a 1% return, when inflation averages 3%? More troubling are the near-retirees who may be waiting for fixed interest rates to trend upward."
Inflation has averaged approximately 3% annually since 1913 and 4% annually during the past 50 years, according to data from the U.S. Bureau of Labor Statistics.
"If your income is fixed, high inflation can significantly cut into your real purchasing power during retirement," said Anthony D. Criscuolo, certified financial planner with Palisades Hudson Financial Group in Ft. Lauderdale. "This is why it's important to continue to maintain some exposure to more aggressive investments, including equities. When it comes to inflation, being too defensive can be just as risky as being overly aggressive."
In a recent investment outlook letter, Pacific Investment Management Company (PIMCO) CEO Bill Gross predicted that interest rates could remain as low as 1% until 2035.
"If Bill Gross is right and low interest rates continue for 20-plus years, retirement plans may need adjusting," said Nuss.
Dubbed the bond king, Gross founded PICMO, a fixed income mutual fund company.
A not-so-conservative adjustment would include high yield and floating rate debt, international and emerging market bonds and even funds focused on investing in high dividend paying stocks to help increase income.
"Investors should be prudent when investing in these areas however as they do introduce risks beyond interest rate sensitivity to their portfolios," said Kevin Ashworth, investment director with EP Wealth Advisors in Torrance, Calif.
While delaying retirement is one way to cope with lower bond rates, investing in stable value solutions is another.
"About half of all 401(k) plans offer stable value funds as an alternative, which guarantees principal and accumulated interest," said Jamie Kalamarides, senior vice president of Institutional Investment Solutions at Prudential Retirement. "Stable value funds also outperformed money market funds and short-term bond funds from 1988 to 2009."
Because they are longer duration, stable value funds can offer higher yields of 2% to 3%.
"Given today's low bond yields, many 401(k) participants don't currently benefit from any appreciable yield or guarantee of principal and earnings in their 401(k) plans' money market funds," Kalamarides told MainStreet.
Favoring floating rate and short-term corporates, Carson Wealth Management Group Financial Advisor Jason Comes suggests investing no more than 20% of assets in general bond funds or bonds.
"For those who can stomach more risk, consider investing in high-quality companies like Wells Fargo, Intel or Verizon, which pay dividends ranging from 2.60% to 5%," Comes told MainStreet. "You may also consider investing in the iShares Select Dividend Index fund, which sports a yield of just over 3%. Temper your risk by putting the balance in CDs and laddering them to different maturities."
--Written by Juliette Fairley for MainStreet