Lock downs have been the largest economic downturn since the Great Depression, provoking a sharp decline in long-term interest rates. We believe that low yields are the new paradigm for long-term investors, rather than a cyclical bump in the road. The current crisis has simply sped up the ongoing shift towards a “lower for longer” yield environment. Interest rates and the implications for retirement portfolios
Retirement savers now need to make hard choices to achieve their retirement income goals. There is a risk of a sharp draw down in asset valuations during retirement. This is a cause of lower interest rates and there effects. So what should a retiree do to protect his hard earned savings. Believe it or not there are steps one can take to preserve their savings.
Lower for longer interest rates
The Fed has signaled to investors that it will maintain an aggressively
expansionary policy stance until inflation and economic activity recovers. Based on swap markets, investors expect that the Fed’s policy interest rate will stay around zero until well after 2023. Expected inflation imply that low real yields could persist until well after the economy recovers. While low risk-free rates are supporting the economic recovery, “lower for longer” yields will be a headwind for long-term savers.
Fortunately, post-war recessions tend to be shorter in length
compared to past centuries. More active fiscal and monetary policies to support economic recoveries by governments. These have been critical to prevent an even greater contraction in economic activity. Preventing higher unemployment and business bankruptcies. Despite aggressive policy support, we believe the current pandemic will leave lasting scars in this economic cycle.
Lower long-term economic growth
Lower long-term economic growth would keep downward pressure on real interest rates and other asset yields. As population aging accelerates, economists expect slower workforce growth combined with slower productivity growth. In addition, population aging has accelerated pre-retirement savings and asset accumulation.
The combination of higher desired savings and lower desired investment has reduced the risk-free real interest rate. Declining real yields can also be self-perpetuating. Lower expected returns and “lower
for longer” rates incentive investors to save more to achieve their retirement income goal. In this context, expect continuing
downward pressure on equilibrium long-term interest rates.
“Lower for longer” bond yields create an asset allocation dilemma for long-term savers. Low yields imply that greater upfront principal is required to match the present value of future retirement income.
Required assets at retirement imply prohibitively high savings rates for many working people. Higher risk portfolios are needed to increase long-term expected returns. Higher risk portfolios also have a greater “risk of ruin” should valuations drop sharply after retirement.
Shifting the focus of retirement thinking
Facing the headwinds of “lower for longer” yields, investors may need to shift the focus of their retirement portfolio thinking.
Whether they understand the linkages or not, lower interest rates have made saving for retirement more expensive, and hence
the planning much more challenging.
Key takeaways include the following:
Prudent equity exposure will likely remain necessary for many long-term savers in addition to significant fixed income duration exposure.
However, retirement savers still need to manage surplus risk to avoid the “risk of ruin” in retirement. Smart portfolio construction can help reduce surplus risk and the tail risk of large stock market downturns.
Alternative investment strategies with absolute return objectives strategies with downside protection using options could play a useful role
In a world of low interest rates forever traditional ways of saving are obsolete. One can no longer just put your money in the bank and save up for retirement. With inflation starting to rev up it’s engines as the pandemic waves flatten your money could be worth less over the coming years.
Once the pandemic has been beaten savers will start pulling their hoards of cash out of their savings. This money is going to be looking for a home that will bring them the highest returns. What does well with a hoard of cash and lower interest rates. One thing for sure when a hoard of cash is looking for a home the value will rise. Figure out what that home is before the herd does and you will do well.