Tuesday, September 18, 2012

QE3 and Retirees ... Things Have Changed ... Thus, We Need to Change, Too

Interest rates are low and are likely to stay that way for a long time to come.

That in turn means future retirement income from fixed income investments will be less than most retirees planned to be the case and in fact has been the case for many years.That said, it is what it is so it's time for many of us to make new plans.

Why QE3 makes retirees queasy describes the situation this way:

". . . the Federal Reserve’s announcement last week of a new, open-ended round of “QE”—quantitative easing, or bond buying designed to grease the wheels of the economy—means downward pressure on rates is likely to continue for a while....

. . . income investors in general are losing due to lower rates. . . . “Zero interest rates have prevented families from rebuilding their net worth … because yields are historically low or even negative.”

Because I know just enough math to get myself in trouble, I decided to try to quantify the unquantifiable. Just how much does a low-rate universe cost a hypothetical safety-seeking retiree? Here’s my stab at some crude, I-am-so-not-an-economist calculations:

Couple X is retiring. They’ve decided to split a $600,000 portfolio into three equal piles and invest it on in 10-year Treasurys, 5-year CDs and a mix of investment-grade corporate bonds that yields the average for that sector. And because they’re a hypothetical couple who live in my head, they’re making all these investments on the same day.

If they’d retired five years ago today—before our most recent recession kicked in—they’d have nailed down annual yields 4.81% a year on the Treasurys, roughly 5% on the CDs and roughly 6% on the investment-grade bonds, according to data from the Treasury Department and the BondsOnline Group. Annual pre-tax income from their portfolio: $31,620, not a bad supplement to the monthly Social Security checks.

If they’d retired today, based on yesterday’s closing prices they’d be earning 1.83% on their Treasurys, 1.37% on the CDs, and 2.92% on the corporate portfolio. Now we’re talking annual income of $12,240—less than 40% of what they might have earned with different timing.

Without making some other aggressive moves or trimming their spending, this couple is more likely to be eating into their principal to pay for living expenses each year. Now they’re wondering if they can wait another year before fixing the roof, and the grandkids are wondering why Pops and Mamaw can’t afford to upgrade to the next-generation Wii.

Bottom line: Today’s monetary policy creates a pool of retirees who feel they have to take some bigger investment risks, whether they like it or not. Spread that calculus over some 40 million retirees over the age of 65, and about $5.2 trillion in assets held in IRAs , and you’ve got a lot of money roaming into some very unfamiliar places." 

Summing Up

It is what it is and it's likely to stay that way for some time.

Buy blue chip companies that have a long history of solid earnings, pay decent dividends and have a track record of sharing increased earnings with shareholders by periodically raising their cash dividends.

Names like GE, Honeywell, Merck, Pfizer, McDonald's, Walmart, Microsoft, Intel, US Bank, Wells Fargo. JP Morgan, Exxon, Nucor, Whirlpool, Pepsi and Coke come to mind. Of course, there are others as well.

In other words, while there's no need to get fancy, there's no reason not to change how we approach things either.

Thanks. Bob.

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