Morici: Low interest rates will affect retirees’ portfolios

Peter Morici   

No matter what President Trump and Congress do about taxes and the like, low interest rates are becoming as certain as aging. That’s good news for young folks buying homes but tough on retirees who rely on CDs and bonds, and people over 55 realigning portfolios for retirement.

Granted, the Federal Reserve is raising interest rates. It has penciled in a 0.25 percent increase for its benchmark commercial bank overnight borrowing rate and three similar adjustments each year until those are “normalized.” However, when the Fed last tightened credit conditions from 2004 to 2006, the benchmark rate peaked at 5.25 percent. This time Fed policymakers are aiming for about 3 percent by the end of 2019.

Long-term CD and mortgage rates won’t rise nearly as much. By my estimate, the best 10-year CD and 30-year fixed rate loan rates should increase from their current 2.4 and 3.9 percent to about 3 and 4.7 percent — those are not high by historical standards.

Interest-rate-sensitive businesses are wagering rates will remain relatively low for the long term.

Prior to the financial crisis, insurance companies sold a lot of annuities, whole life policies and similar products premised on investing premiums at higher interest rates than subsequently prevailed and have seen their profits squeezed. Rather than bet interest rates will return to pre-crisis levels, Metropolitan Life and others are spinning off those activities into separate companies.

If you want to bet against Charlie Brown — have at it. However, if you are holding a big chunk of savings in a money market account in hopes of a significant jump in interest rates before buying a CD or government bond, I would suggest that’s a bad strategy.

If you are out shopping for a house, expected price appreciation in the neighborhoods you are considering may push you to buy now, but don’t feel pressured to make a purchase because the realtor says, “The Fed is raising rates.”

It is, but the impact on what you pay for a mortgage will not be large over the next year. Consider whether avoiding the impact of another 0.25 percent on your monthly payments on a 15- or 30-year fixed rate loan is worth the extra risk of a precipitous purchase.

If you have an adjustable-rate mortgage and plan to be in your home at least another three years, refinance now. A lot of those loans are tied to short rates like the London Interbank Offered Rate, which will move roughly in tandem with the federal funds rate, and you will see bigger leaps in monthly payments as the Fed tightens. Also, that should be a factor pushing new homebuyers toward a 15- or 30-year fixed rate instead of an adjustable mortgage with a low teaser rate.

Investors more than 10 years from retirement should consider how much cash they need on hand to cover about six months of expenses or upcoming college tuition and beyond that, sink their money into the stock market.

For cash, a CD or Treasury security ladder makes sense — divide your fixed income savings into three buckets and buy one-, three- and five-year maturities. If the economy and Fed keep on their present courses, you can purchase longer maturities — perhaps 10 years — as those mature.

For the rest of your nest egg, an S&P; 500 index fund is a wise choice.

Remember, stocks pay dividends and the current rate on the S&P; 500 is 1.9 percent — almost what you would get on the best 10-year CD or a 10-year Treasury security — and you have the upside for appreciation.

Currently, the S&P; 500 is selling for about 25 times earnings, and in line with the average of the last 25 years. Factoring in expected earnings growth, it’s a lot lower and less expensive than the historical average.

This is not the time to bail out of stocks, and if you have extra cash or a disciplined savings program, you should be buying in gradually each month.

The folks at USAA, Vanguard and other similar services offer S&P; 500 and similar index funds at very low fees and can arrange for automatic transfers from your checking account each month.

Over the decades, Angela and I pursued such a strategy, and that’s why we can afford to retire.

Peter Morici is an economist and business professor at the University of Maryland, and a national columnist. © 2017, The Washington Times.

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