Interest rates are dynamic. They change according to many factors, the leading of which being the overall health of the economy. These strategic changes might help to spur growth and recovery in the economy, but being a retirement saver at the mercy of interest rate movements is a scary place to be.
When you buy a bond, the interest rate for the coupon payment is going to be determined by the prevailing interest rates. If interest rates are high, then bond coupon rates will be high as well. This is great when you buy a high-interest bond and then rates go down—because you’re getting higher payments than people buying new issues at lower rates.
The problem is that this isn’t always what happens. Many bond buyers, including those in recent years will find themselves stuck with a bond issued during a low-interest rate period and then, as rates rise, will be getting far less in coupon payments than people buying new issues. Worse, if they were counting on getting a new bond with the same interest rate they had on a recently matured issue, but the new bond is issued during a low-interest period, they may find their income greatly reduced.
Not every senior can get through retirement without taking on any new debt. If a senior should need an auto loan, mortgage or equity loan or even to carry a credit card balance, then a rising interest rate environment can spell trouble. Rising interest rates are shifted onto loan and credit card customers. For long-term loans, those rates can be fixed for years and there could even be a prepayment penalty charged against those who try to pay the debt off early. These are definitely factors to consider before getting a loan or using a credit card after retirement.
Rising interest rates can be problematic—but that doesn’t mean falling interest rates don’t bring in their own sets of issues. Not only do falling interest rates create lower fixed income returns, they also help to increase spending, which means they can be behind higher rates of inflation. Inflation occurs when the general price of goods and services rises, which means that during inflationary periods, retirees will have to spend more of their income just to maintain their lifestyle.
Fixed-income products can have a very important place in a retiree’s portfolio, but retirees also need to consider adding products that are protected from interest rate fluctuations, offer stable, lifetime guarantees, and create inflation protection.
In the next volume of the THREATS TO POSTRETIREMENT INCOME series, we’re going to talk about how a lack of guarantees in your investments could be a downfall in your future income plans.