Negative interest rates; do you want risk, now or later? by Rico Dilello
My home library still contains text books from the days when I studied to become a financial advisor. A lot has changed during the past fifteen years since I wrote my final exam. A moderate –risk retirement portfolio back then recommended holding 60% stocks and 40% bonds. There were no chapters covering negative interest rates.
Today there are more than 7 trillion dollars of government bonds world-wide with yields below zero. That means investors buying bonds and holding them to maturity won’t get all their money back (scary). There is some speculation that Canada and the U.S. may be force to follow the rest of the world and go down the negative interest rate road.
Fifteen years ago, when a person turned 65 and retired, they had the ability to earn money on their cash at an above 5% yield on their risk-free Treasury bond portfolio. This would give them a concrete chance at running ahead of inflation with very little risk to principal. This opportunity no longer exists and it may take another decade or more for interest rates to get back to normal.
The problem is life expectancy is rising in an environment where interest rates are falling. Now, my wife and I are retired and in our early sixties. There is a 50% chance that one of us will make it into our 90’s. It seems appropriate to wonder whether the 60/40 rule remains a prudent strategy for seniors, who don’t want to outlive their retirement savings someday?
The great recession of 2008-09, taught me that volatility is not the true risk for seniors living in retirement. It is an unavoidable permanent feature of the investing process. Stock prices will always be far more volatile than bonds. However, it only took three years for stock prices to recover from their 2009 lows. The true risks are the permanent loss of capital and the possibility of running out of money.
Advice from 85 year old billionaire, Warren Buffett
“It is true that owning equites for a day or a week or a year is far riskier than leaving funds in cash-equivalents. For the great majority of investors, however, who can and should invest with a multi-decade horizon, price declines are unimportant. For them, a diversified equity portfolio, bought over time, will prove far less risk than dollar – based securities.”
I have to admit that I am a big fan of Mr. Buffett and my tolerance for risk is much higher than the average senior. My 84 year old mother is quite happy that I invested 80% of her retirement account ($76,000) back in 2001 into equities. Over the past 15 years, my mother withdrew an average of $5,500 per year and she still has $67,000 today. There is no doubt that her retirement account would have run out of money using the old 60/40 rule or significantly reduced the amount of her annual income.
Ask your advisor this simple question, “When should I take some risk, now or later?”
By Rico Dilello