Historically, retirees have sought the safety of bonds for much of their retirement savings. But with bonds yielding so little — a situation likely to continue — what’s a retiree (or near-retiree) to do?
SMI’s executive editor Mark Biller offered advice this week on Moody Radio’s MoneyWise Live.
To listen, click the play button below. Scroll down for the transcript.
(And for more radio appearances by members of the SMI team, visit our Resources page.)
The Retirement Investing Challenge – Oct. 19, 2020
MoneyWise Live, with Rob West and Steve Moore, airs daily at 4:00 p.m. ET/3:00 CT.
Steve Moore: "The Retirement Investing Challenge" — that’s next, right here MoneyWise Live.
Well, Rob, our friend Mark Biller is the executive editor at SMI — Sound Mind Investing — and they have a detailed article in their October newsletter about ways to keep inflation from eating away at your savings. And, of course, Mark being Mark, he’s speaking to us today through his mask.
Rob West: (chuckle) That’s right, because Mark is always doing things the way he should. And I’m really excited about this topic. You know, our listeners need to check it out — because, Mark as you know, a lot of people are concerned about these low interest rates and what that could mean for their retirement dollars. So welcome back to the program.
Mark Biller: Well, thanks guys. It’s good to be with you,
Rob West: Obviously, things you do before retiring have the most impact on your saving, getting out of debt maximizing contributions to your retirement plan. And we talk a lot about having an emergency fund, but having done all that folks nearing, or even in retirement still have to face a tough question. And so I know that’s at the heart of your article and really at the core of what we’re going to be talking about today. So fill us in.
Mark Biller: Yeah, that’s right, Rob. Y’know, the question is, which is of greater concern to you potentially losing some of your principal in the short run or losing your purchasing power to inflation over the course of your retirement lifetime.
A lot of retirees historically have been very uncomfortable with the idea of ever dipping into their investment principal. They want to just live off the income of their investments. And that mindset often will limit retirees to savings-type investments: CDs, savings accounts, that type of thing. You know, the issue really is that a generation ago, that type of approach might’ve made sense. You know, 20 years ago you could have a decent bond portfolio yielding 7½%.
But today with super-low interest rates that just really doesn’t get it done because interest rates are so close to zero, and the fact that people are living longer, that means that most retirees have got to continue investing at least some of their money a little bit more aggressively in order to maintain their purchasing power over a 15, 20, 30-year retirement.
Rob West: Obviously, Mark, these retirees need to have some allocation to fixed-income investments, even if rates are low. So what advice do you have there?
Mark Biller: Yeah. So at the heart of this is the Federal Reserve’s interest rate policy, and that’s been brutal over the last decade, for the most part — it’s been wonderful for borrowers who are borrowing at these low rates but brutal for savers. And so, y’know, really for savers, it’s kind of a meager list of options. Now, here are a few ideas. None of them are awesome because we just don’t have great options right now, but there are some things we can do.
And the first of those is to not settle for your local bank’s savings accounts or CD rates. Very important to compare your local rates to the higher rates that are available online, usually from online-only banks. Now that difference may only amount to maybe half a percent or so per year, but a lot of retirees carry large savings balances. So even a small percentage difference can really add up in terms of dollars. We typically direct our SMI readers to bankrate.com and also depositaccounts.com as good reference places to look for those higher yields.
Rob West: Yeah, and that’s really key because you want to get those yields up and that would include not only savings accounts, but of course, CD rates as well, which in this environment, you may certainly pass on the long end of the CDs and stay on the shorter end.
We’ll talk about much more related to this. And again, that stock allocation as well, right around the corner.
Rob West: Mark, before we dive back into this, when we talk about this idea of retirement, clearly we want to look at it through a biblical lens. What thoughts might you offer to our listeners, as believers, as to how they should even think about this season of life that might be particularly related to their biblical worldview?
Mark Biller: Yeah, well, that’s a deep topic in and of itself Rob, but I think that biblically, rather than looking at retirement as kind of like the "coast" zone — "I’ve made it past the finish line and now I can just go kick back somewhere on a beach or a golf course." You know, I think it’s appropriate to look at retirement more as maybe a redirecting, a different season. But, y’know, we’re always from birth — or at least when we become cognizant of the Lord’s work in our lives — until the end of our days, we’re supposed to be looking for how the Lord wants to use us. So maybe a redirecting, a slowing down, maybe a change of focus — but certainly not a, you know, "I’m over and I’m out to pasture at this point." That’s not the right approach.
Rob West: That’s exactly right. I couldn’t agree more, you know, it’s that season where you have the most wisdom, the most experience to offer in service to the Lord. So perhaps we’re thinking about retiring to something and not from something — but clearly, your financial resources, God’s resources, are a part of the equation. So how do you make them last for the rest of your life, once you reach that season of life — especially in light of these lower interest rates that we currently find ourselves in?
We mentioned just before the break, Mark, CDs — and that’s obviously a very common, quickly-thought-of type of fixed-income investment. When we talk about CDs, we often talk about something called the "ladder." Give us your perspective on how we should think about this portion of our portfolios.
Mark Biller: So a CD savings ladder, the idea is that longer-term CDs yield more than shorter-term CDs. So most retirees want to have regular liquidity. They don’t want to lock up all of their money for long periods of time. A lot of times, they’ll shy away from CDs of longer terms because they want to have access to their money sooner. The idea of the ladder is to stagger different CDs of different maturities so that you have regular access to the principal, but eventually you can set this up so you’re earning the longer CD rates, which yield more.
So, an example of how you would do this is, you might start out by buying CDs of say six months, 12 months, 18 months, 24 months. And by doing that every six months, you’re getting access to some of your principal in case you need that. The money that you don’t need right away for your spending you can then turn around and reinvest at a longer term. So you’d take that six months CD money when it matures. And you’d reinvest that and say a new 24-month CD at the end of the ladder. So your next CD is always just six months away, but eventually, they’re all two-year, three-year, four year — the longer-term CD rates.
Now, as you mentioned right before the break, Rob, with rates so low, you don’t want to be locking up your money for really long periods, like five years right now. Eventually, as rates rise, maybe a five year would be a great goal for all of your CDs to be those longer-term rates. But right now, probably wiser to keep it a little bit at the shorter end.
Rob West: So if we look at the fact that we’re living longer, therefore many retirees could spend 20 or 30 years in retirement, and then we factor in the low interest rates, we factor in inflation, we factor in the rising costs of medical expenses — we really need to think about what you call a "total return" approach to our income needs. So give us an example of what that might look like.
Mark Biller: Sure. So let’s just consider two options. One is a $100,000 bond portfolio that’s yielding 3%. The other is a $100,000 combination stock-and-bond portfolio that’s only yielding 2%. Now at a glance, that 3% bond yield might seem better because it’s going to give you $3,000 a year of income whereas that combo portfolio is only going to give you $2,000 of income. The key here is you need to look beyond that current income because that’s the only part of the picture.
Historically stocks have tended to provide higher total returns than bonds. So we need to look at the yield — the 2% or 3% — plus the capital gains. So if we just continue the example, if the stocks in that combination portfolio are growing at, say, maybe 5% per year, now that combination portfolio is giving you the $2,000 of yield of income. Plus it’s growing another %5,000 in capital gains. Now that’s a total return of $7,000, which is considerably more than the $3,000 of income that the bond portfolio was giving us.
And the key to making this work is you have to be willing to sell a little bit of your principal to make up the difference in income. That’s where retirees sometimes are a little bit reticent. If that $2,000 of income isn’t enough, you can just sell a few of your shares from the bond-and-stock portfolio to make up the difference. And even after doing that, typically you come out ahead over time.
Now, of course, there’s no such thing as a free lunch. So the downside is there are going to be years when the stocks in that combined portfolio will lose some value. But, y’know, you’re taking this combination approach and recognizing this is a long-term game that over most longer-term periods, five years, 10 years, and so on, stocks are going to outperform bonds. Now there’s a great table in the article that shows everything I just said, I know it’s hard to listen to all these numbers, but this table lays this out in black-and-white. So if this is something listeners are interested in, I really encourage them to look at that in the article online.
Steve Moore: The article we’re discussing with Mark Biller, The Retirement Investing Challenge. You’ll find it when you visit them online, soundmindinvesting.org. And we’ll be right back.
Rob West: Well, Mark you know, there’s something called the "rule of 100." I know you’re well familiar with it, we’ve talked about it here on the program as kind of a rule of thumb that many advisors use to kind of ballpark what your mix should be between stocks and bonds related to your age. So, describe what that is and whether or not that holds up with what you were describing earlier in this total-return approach.
Mark Biller: Sure. So very that rule of 100 is just, you subtract your age from 100 and that’s the percentage of your portfolio that should be in stocks. And, y’know, over the last four decades or so, that’s worked pretty well because bonds have had pretty good returns as interest rates have been steadily declining from the 15% or so level of the mid-80s, early 80s, until today.
The problem is that that’s probably a little bit conservative given today’s low yields. You know, I wish that wasn’t the case, but the Federal Reserve and really central banks all around the world, over the last dozen years, since the financial crisis, they’ve intentionally created this dynamic to push people out of safer, fixed income and savings vehicles and kind of force them out the risk curve into riskier investments.
And that, you know, this whole topic that we’re talking about today is really so important, and it’s one that a lot of retirees don’t fully understand, but over time, the best predictor of what future bond returns will be, has been what current bond yields are today. So with bond yields so, so low today that suggests that overall bond returns are going to be quite low over the next several years. And so it’s going to be very difficult to generate the types of returns that retirees have been used to over the last few decades over the coming years.
Now, unfortunately, it’s not like stock valuations are screaming values either. So it’s not like there’s an easy answer to this. But that’s really why we put the time and focus on the available options through articles like the one that we’re discussing today.
Rob West: Well, I’ve heard some suggest that that new number is not 100, but 110 — which basically means instead of a 70-year-old having 30% allocation to stocks, they might now have 40%. Would something like that, you think, take us in the right direction.
Mark Biller: Yeah. I mean, it’s certainly going to be better. And y’know, rules of thumb they’re useful as general guideposts. Of course, we’re always going to suggest that people try to dig in a little bit more to their specific situation.
You know, the thing that people have not really wrestled through is we’ve, we’ve been dealing with lower and lower yields now for some time, but what is just around the corner, potentially, is: What if interest rates actually begin to rise over the next several years and bond returns actually could be flat or even negative? That really will throw a lot of these rules of thumb for a loop because we’ve had 40 years of one direction, and we’re kind of looking like we’re towards the end of that pendulum swing and eventually, things could swing back the other way.
Rob West: Well, the bottom line here Mark, is we need to perhaps consider what our retirement portfolio should look like — and perhaps in a different way in light of the environment we’re in and what we see coming on the horizon. This article is a great step in that direction, so go check it out at soundmindinvesting.org — and just keep in mind, God is our provider, not our investments, so that’s where our trust should be.
Thanks for stopping by my friend.
Mark Biller: Always a pleasure, Rob. Thanks!