How Low Rates Are Ruining Your Retirement

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For years, interest rates have seemed to be as low as they could go -- and then have proceeded to go lower still. With most short-term investments paying little more than 0% and even rates on 10-year Treasuries just recently popping above the 2% mark, it's hard to imagine the possibility of further declines.

But even if rates don't fall any further, they're still taking a big toll on investors. Moreover, the impact goes well beyond those who desperately need to draw income from their investment portfolios -- and it could have an even bigger impact on long-term investors who don't make the right moves.

A no-win scenario
The plight of retirees and other income-hungry investors in the face of seeing their investment income evaporate is a tragic story. In many cases, households have faced the double-whammy of having breadwinners lose their job income at the same time that any savings they've been able to squirrel away had a big reduction in the interest it paid. To get the income they need, many conservative investors have taken risks they never would have dreamed of -- and while that's a gamble that has thus far paid off, the next downturn for the stock market will test their mettle and potentially create even bigger problems.

But the more subtle impact of low rates affects everyone. Unless you're in a position in which you can afford to invest everything in riskier assets -- and few people are -- then the investments you rely on for safety and stability are slowly but surely losing their value every day.

Settling for nothing
To get a better understanding of exactly what's at stake, consider what accepting a 2% return on a 10-year bond really means. Investing $1,000 in a bond, you'll get $10 payments twice a year, and then get your $1,000 back in 2022. That's not much income, but if you're a nervous investor, knowing that you'll get your principal back in full at the end of 10 years has some value.

But two factors will eat away at the value of that $1,000 bond. First of all, you'll have to pay tax on the interest payments you receive, so the $20 you get each year may turn out to be closer to $15 after taxes. And even more insidiously, inflation will eat away at the purchasing power of your $1,000 investment -- so that by the time you get your money back 10 years in the future, it will likely have lost more than a quarter of its intrinsic value, even with modest inflation rate assumptions.

Put another way, even if you reinvested your interest payments, you'd still end up losing money after considering inflation and taxes. Given that you want to see your money grow over time, a 2% yield on a bond clearly won't get you where you need to be.

Turn the tables
Instead of accepting your fate, one way to address the situation is to figure out which businesses are benefiting from the current rate environment. The most obvious beneficiaries of low rates are the companies that are responsible for paying them to you: banks. JPMorgan Chase (NYSE: JPM  ) , Wells Fargo (NYSE: WFC  ) , and US Bancorp (NYSE: USB  ) have all announced huge dividend increases following their successful passage of the Fed's recent stress tests, and the reason is simple: They've successfully used cheap financing from their customers to earn back big portions of the profits they lost from the mortgage meltdown. By investing in banks, you can hedge yourself against the devastation they're wreaking on the fixed-income side of your portfolio.

Another possibility is to protect yourself against inflation directly. One main driver of higher prices in the past has been the cost of energy. By putting a portion of your portfolio in the high-yielding energy stocks Chevron (NYSE: CVX  ) and ConocoPhillips (NYSE: COP  ) , your shares should rise alongside oil prices, earning you a profit you can use to offset your higher household expenses.

These aren't perfect solutions, as they increase your investment risk. But with rates so low, the alternatives are even less attractive.

Don't ruin your retirement
Low rates act as a tax on savers, and we're all paying the price. But by taking steps to protect yourself, you can at least try to offset some of the cost of low rates and make the most of a bad situation.

Regardless of rates, stocks continue to play an important role in investors' retirement portfolios. Learn about three promising stock ideas that can help you retire rich. It's free, so grab your copy today while it's still available.

Fool contributor Dan Caplinger doesn't want anyone's retirement ruined. You can follow him on Twitter here. He doesn't own shares of the companies mentioned in this article. The Motley Fool owns shares of JPMorgan Chase and Wells Fargo; and has created a covered strangle position in Wells Fargo. Motley Fool newsletter services have recommended buying shares of Wells Fargo and Chevron. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. You can bank on The Fool's disclosure policy.

Read/Post Comments (8) | Recommend This Article (10)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On April 03, 2012, at 3:48 PM, TheDumbMoney wrote:

    Technically, I think banks make money on a steep yield curve, not just on "low interest rates." Which is why Operation Twist was such a drag on Big Bank earnings.

  • Report this Comment On April 03, 2012, at 4:00 PM, 123spot wrote:

    I dunno. Maybe I'm just stubborn or contrary (pretty sure that's the case, actually). Every time I see these financial articles saying " they've got you, you must yield to risk", I raise a little more cash and put it in a low interest FDIC insured short term CD. If all of this pesuasion works on the population at large, cash will be rare and valuable. I'm keeping 50% of what I have in it. Spot

  • Report this Comment On April 03, 2012, at 4:00 PM, 123spot wrote:


  • Report this Comment On April 03, 2012, at 4:48 PM, XMFGortok wrote:

    Could you not invest some of your wealth in Gold or Gold related stocks to protect against inflation (Not as a wealth generator, but as a wealth protector)?

  • Report this Comment On April 03, 2012, at 6:35 PM, ouchtouch wrote:

    When currency issuers repress savers by keeping interest rates artificially low and negative in real terms, the smart money has always fled to gold, and always will. Ask China if it is done changing it's dollar reserves to gold.

  • Report this Comment On April 03, 2012, at 8:58 PM, TMFGalagan wrote:

    @dumberthanafool -

    I'd agree, yet it looks increasingly apparent that the Fed will give up on Operation Twist before it loosens the clamps on the Fed Funds rate. That means that banks could become even more profitable during any lag between higher long-term rates and higher short-term rates.


    dan (TMF Galagan)

  • Report this Comment On April 03, 2012, at 9:00 PM, TMFGalagan wrote:

    @TMFGortok -

    Gold is a traditional inflation hedge, but it hasn't always been reliable. Gold has had long periods during which its real returns were highly negative -- and admittedly, other periods when they were highly positive. The correlation with inflation is far from perfect.


    dan (TMF Galagan)

  • Report this Comment On April 04, 2012, at 8:53 AM, Danl48 wrote:

    Has everyone bailed on intermediate treasury funds including TIPS entirely??

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