Jan 13 2014, 12:23pm CST | by Forbes
For years, the Fed’s efforts to pump money into the financial system through quantitative easing have held down interest rates. However, interest rates are rebounding from their historic lows, affecting bond prices, mortgage rates, and potentially stock market returns. Will rising rates be good or bad for retirees?
Thomas: I think that rising interest rates will hurt retirees because they will drive down bond prices because bond prices generally have an inverse relationship with interest rates. This will negatively affect the portfolio values of fixed income investors.
Robert: Yes, but over the long term, rising interest rates will present real opportunities for fixed income investors. For example, investors might finally be able to go to the bank and get CDs at 5-6 percent, which is impossible now, offering higher potential income for retirees. Retirees used to be able to rely on fixed income investments for income in retirement, but the Fed’s easy money policies have decreased the interest payments investors have been able to get.
In the short term, while rising interest rates might hurt retirees by driving down fixed income prices, in the long term, there will be some possible investment opportunities to consider as rates rise.
What options do retirees seeking income have in a rising interest rate environment?
Investors can limit their interest rate risk by sticking with shorter-term bonds that expose investors to less risk of rising interest rates. Duration is a concept that bond investors should become familiar with; in basic terms, duration measures the overall interest rate sensitivity of a bond or portfolio of bonds. In order to reduce the potential negative effects of rising rates, talk to your advisor about strategies like reducing bond duration or exploring fixed income securities that rise with inflation.
You should also consider the benefits of reducing your borrowing needs, so that rising mortgage rates or credit card interest rates don’t affect your household finances as much. If you’re anticipating making a major purchase, like a house or car, consider accelerating your buying process to take advantage of lower rates now.
Ultimately, while rising rates may be bad news for those who haven’t jumped on lower rates to refinance or buy a house, and for large borrowers like municipalities and corporation, they are good news for retirees who can look forward to the potential for higher income.
Whichever financial strategy you and your financial advisor choose to pursue, it’s important to prepare mentally to stay the course even when the ride gets bumpy. One of the biggest mistakes you can make as an investor is to react emotionally to changing market environments.
*Securities and advisory services offered through SII Investments, Inc., member FINRA, SIPC and a Registered Investment Advisor. Fross and Fross Wealth Management and SII Investments, Inc. are separate companies. SII does not provide tax or legal advice.
Source: Forbes Business
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