Retirees Walloped by Near-Zero Interest Rates

How to cope with such low rates?

• Bonds. One obvious course is to transfer some money market funds into highly rated municipal bonds, which now often pay 3 to 5 percent in annual interest. While such bonds do carry the possible risk that the issuing entity could default, most investors probably won’t lose sleep over the notion that the Los Angeles Community College District or the Florida Housing Finance Corp. might fail to pay their debts. Another possible risk: Bonds can decline in value if not held to maturity.

• High-yielding stocks. Some equities still pay a 3 or 4 percent dividend, offering a retiree a better return than a savings account. But such investments carry the risk that the price of the stock could drop, leaving the investor with less money when it’s time to sell.

• Government-guaranteed mortgage security funds. One low-expense Vanguard fund, for instance, invests primarily in bonds from Ginnie Mae, the government-backed mortgage guarantor, and was recently yielding 3.71 percent.

• Reverse mortgages. These are controversial, in part because of hidden fees and loan terms. But a reverse mortgage generally allows people 62 or older to convert the equity accumulated in their houses into a tax-free stream of cash, without reducing Social Security or Medicare payments. These loans are repaid after the owner dies or moves. However, the collapse of real estate prices may have closed the door on this option for many.

Retirees subsidizing the banks

The nation’s retirees are essentially financing the nation’s massive bailout of banks, notes Edward Yardeni, former chief investment strategist for Deutsche Bank Securities and now an independent analyst. “It’s a Main Street subsidy of the whole banking system, that’s for sure,” he says.

“One of the main reasons the Fed lowered rates to zero was to create a very profitable spread for the banks, to help bail them out at the expense of depositors,” Yardeni notes. “That’s not a political view; it’s a matter of fact. So anyone who has money in a bank or money market fund is getting almost nothing for their investment, and that’s unsettling.”

Indeed, because so many older Americans want to preserve capital and avoid risks, Yardeni says, “we’ve seen a record inflow of money into bond funds,” where the investor must shoulder the potential risk of a default or capital losses.

Jon Wax, a certified financial planner in Tampa, Fla., says many of his clients nearing retirement wonder how they can find a stable source of long-term income once they stop working.

“There is a natural tension between wanting to see the backbone of our economy solidified and recover and the sacrifices people are making in terms of the lack of yield on safe investments,” he says. What’s important, he adds, is to try to help customers differentiate between monthly cash flow and longer-term performance.

For growth, take a little risk

That translates into getting older investors to hold part of their assets in a low-yielding money market fund to pay for monthly needs, while also putting long-term funds into somewhat riskier investments, such as stocks, which should ultimately bring higher returns.

Wax is also reminding clients that they shouldn’t expect the next recovery to trace the rocket-ship trajectory of past rebounds that brought high growth, rising real estate prices and surging stocks.

“We are conditioning everyone to understand that the ‘new normal’ may well mean sluggish growth,” rather than a rapid recovery, he says. He also warns that one possible consequence of all the cheap money flooding the banking system today could be rampant inflation down the road.