The Federal Reserve recently cut interest rates for the first time in more than 10 years. If you’re wondering what this means for your retirement, the good news is that the modest 0.25% cut is unlikely to have much of an impact in the short term. But if rates continue to fall, there could be a real squeeze.
You may already know that falling rates mean lower yields on fixed-rate investments. But here are a few other things that lower interest rates affect:
Social Security Trust Funds
Social Security’s trust funds are invested in U.S. Treasury investments. When rates fall, the funds earn less interest on their holdings. This could potentially speed up the demise of Social Security’s cash reserves (currently expected to occur in 2034). Note that even if this happens, close to 80% of Social Security benefits will be paid out through 2090.
Government and Municipal Pension Funds
Lower rates make it more difficult for the bond component in pension funds to hit its target rate of return. As a result, pension funds start buying riskier (and possibly higher-cost) assets.
Long-term Care Insurance Premiums
When rates drop, insurance companies don’t earn as much interest on premium payments they receive and invest. In order to cover any possible shortfall in paying out benefits, they have to hike premium rates.
Now let’s talk about two items retirees should consider putting on their to-do list whenever interest rates fall:
Reassess Your Risk Tolerance
As I mentioned before, a rate cut means lower returns on bonds, annuities and savings accounts. Retirees often rely upon interest income from bonds, annuities, and bank savings accounts to pay the bills. Many people consider moving into higher-risk investments to try to make up for the loss. This is a mistake.
How to avoid it? First, figure out how a sustained low-rate environment might affect your budget. You may need to make some changes to your investment strategy. One possibility is investing in stocks of well-established companies that have solid histories of paying dividends.
Build a Ladder
Consider staggering the maturity dates of your bond or CD purchases over a range of years. This provides diversification benefits and can help you manage your cash flow. It will also allow you to lock in potentially higher yields if interest rates continue to fall.
Close to retirement – or already there – and worried about falling rates? Wondering if laddering your investments or reallocating your assets is right for you? Click here to set up a meeting with one of our advisors today.