Broker Check

Retiring With Extremely Low Interest Rates

| May 22, 2020


One of the smartest things I’ve read recently is “No One Knows What Will Happen!” Other than in “fixed” ("rigged," not "repaired") kinds of things …. i.e. fixed horse races … fixed elections …. etc. it is obvious in my own opinion that fortune-telling is imprecise. My crystal ball is cloudy but if someone could actually predict the future with even a little bit of consistency, they could make gazillions and so they wouldn’t be telling other people about it! [IMPO 😊] That is also true about our Post-COVID-19 world. No one knows what it will be like. In The 7 Immutable Laws of Investing. [Future Post: Stay Tuned,] one of those 7 laws is, “This Time Is Never Different.”  But IS this time really different? I don’t know. Neither does anyone else!

Primary Audience for this post:

  1. Within 5 years of retirement or already retired.
  2. Realistic lifetime projected income from a 100% fixed income retirement nest egg at currently very low interest rates will not meet your own retirement goal(s.) 
  3. 100% fixed income retirement nest egg might not maintain your purchasing power cash flow goal in retirement
  4. Therefore you will need some growth and / or more current income from your retirement nest egg to meet your goals.
  5. Protection of your accumulated nest egg is still critical.

Executive Summary

  1. Many retirees and / or many of those close to retirement need to protect their existing Retirement Nest Egg.
  2. Individual investment grade bonds (NOT bond funds) had been a source of some income.
  3. And a source of some stability.
  4. "Negative" interest rates might mean that the income portion of investment grade bonds might be much more difficult to include in portfolios for now.
  5. If you are investing primarily for your grandchildren's inheritance, maybe no big deal.
  6. But if you need your retirement income to pay for medical care and food, a bigger challenge.

Where is all the Toilet Paper? And Pasta? Etc.

"Ceteris Paribus" Definition

"With other conditions remaining the same.  Nothing else changes. All other things remaining equal. Everything else held constant."

The problem of course is that IRL In Real Life it is usually impossible to change just one thing and hold everything else constant like a chemistry experiment.

I won't do all the non-financial research so I'll be general. Before Pandemic, "a lot" of food was prepared and eaten outside the home. Big percentage of the total in U.S. Turns out there are two different food distribution systems and, to some extent, never the twain shall meet. So now, not overnight but pretty close, a "typical" single family home with 2 adults and 2 school-age children in the suburbs or many cities had no one there during a typical work day during the school year. So, some people some of the time packed their lunch. But four people out of the house generally mean "a lot" of food prepared and eaten outside the home. And since few of us in US carry toilet paper in our backpacks or briefcases, all of the toilet paper needed while they were out of the house was supplied by others, not bought at the local grocery store, Big Box etc. Now all those meals are being eaten at home. Some ordered out and brought home but many more prepared at home. So rice, pasta etc. etc. was and might still be hard to find on store shelves. And, of course, TP.

So it was not and it is still not "ceteris paribus." Other things are NOT equal. Pandemic is Real Life not an experiment.

"Negative" Interest Rates ... Milk Dumping ... Negative Oil Prices - How is all this even possible?

The commodity markets are a not bad example of how microeconomics applies and / or has been developed. The basic assumption is many buyers and many sellers and a product that is undifferentiated. e.g. oil. pigs. milk. (Meeting some standardized quality.) So no one buyer or one seller can influence the price. So the markets are auctions and the price will be bid down or bid up to meet more or less demand. But what happens if there is zero demand. Buyers have all the milk they want. (Leaving aside those of us who are lactose intolerant who wonder if the US still subsidizes dairy farmers. But I digress.) Same with oil. So the oil producers had still have lots of oil. But they ship it off to customers. They don't hold it. So now no one wants it. Storage costs money. So, literally, the producers had to pay someone to take the oil from them because then that "buyer" (who is now a "seller") will be responsible for storing the oil and paying for the storage tanks, facilities, rent etc.

Similarly with money

In general [before “This Time Is (Really (maybe) Different,] if you had money, you could put it in the bank and earn (a little) interest. Or you could put it in the US bank – government bonds – and earn interest from the US Government.  But in what was already a low interest environment, the banks and / or the US Government (and other countries also) at the moment don’t have the ability to earn money on the “spread.”  Since banks are (or are supposed to be) profit-making businesses, if they can't make their profit on the spread, they have to charge you for holding your money safely. Hence, "Negative Interest Rates."  As Ben Carlson said, money has to go somewhere.

I actually met a guy who never became a client but he told me that he had cash buried in his back yard. (I never checked.) But for the great majority of us who think that is a Really Bad Idea, then, what do you do if you have more money than you currently need? But you don’t want to risk it. Used to be, you could earn a little interest with complete safety. At the moment, depending on what country you live in … maybe not. Maybe you literally have to pay – i. e. “Negative Interest Rates” … for someone to actually hold your money safely.

What is Reinvestment Risk? Oversimplified Bond Ladder Example

  1. A purely hypothetical example:
  2. December 31, 2019 par value of an investment grade bond ladder was $300,000
  3. March 31, 2020 no bonds were called, added or redeemed.
  4. Par value of the bonds was still $300,000.
  5. No capital loss at par value.
  6. Client received interest e.g. of 1% for the quarter. $3,000.
  7. 4% Yield on the bond ladder in total.
  8. The above now sounds to me pretty good, although one year or two years ago when it was available, it looked too conservative to many.

Sooner or later, every year typically, a bond will mature and be redeemed. What now? It might not - probably it is not - possible to find an investment grade bond yielding 4% to replace the bond that matured. Reinvestment Risk. 

So the owner / retiree / preretiree is faced with unpleasant choices:

  • Replace the bond that matured with another investment grade bond yielding considerably lower.
  • Replace the bond that matured with a lower quality (aka higher risk) bond of the same interest rate.
  • Don't add another bond.
  • Find something else to invest in.

Related Links