Image source: Flickr/ 401(k) 2012.
Retirees have suffered greatly in recent years, in large part because the Federal Reserve has kept interest rates low and therefore made it difficult for them to earn money on their savings. Recently, though, interest rates have started to move higher, and that opens the door to a new opportunity for smart retirees. Below, we'll look at three strategies you can use to boost your retirement income in a rising-rate environment.
Matt Frankel: Interest rates have begun to rise, but how much and how fast they'll rise remains to be seen. For this reason, one smart way to take advantage of rising rates is by "laddering" your bonds and CDs.
A ladder basically means splitting your investments into varying maturities. For example, let's say that you have $50,000 you want to invest in CDs. As of this writing, some of the national average CD rates are:
|
Product |
Interest Rate |
|---|---|
|
1-year CD |
1.09% |
|
2-year CD |
1.28% |
|
5-year CD |
1.85% |
Data source: Bankrate.com.
It may seem like a smart move to simply buy $50,000 worth of five-year CDs, but you'll miss out if rates keep rising. Instead, split your money five ways and invest $10,000 in CDs that mature in one year, another $10,000 in CDs that mature in two years, and so on.
The idea is that one-fifth of your portfolio matures every year, allowing you to buy $10,000 worth of five-year CDs at the then-current interest rate. This way, you'll have some free cash to take advantage of interest rate spikes. After all, the five-year CD rate was over 12% in the early 1980s, and was over 4% as recently as the mid-2000s, so wouldn't you want to be able to take advantage? Conversely, if interest rates suddenly drop, four-fifths of your portfolio will still be paying you the older, higher rates.
This method is effective on all types of fixed-income investments, such as Treasuries and corporate bonds. If you want to take advantage of interest rates as they rise, but still want to get some income in the meantime, a ladder could be the way to go.
Sean Williams: The initial reaction some people will have with rising interest rates is to begin pouring their money back into CDs because of their safety. Since bond yields and prices have an inverse relationship, rising rates mean bad news for bond yields, further provoking the move into CDs. Personally, CDs may be a smart option years from now, but with CD yields potentially underperforming inflation, I'm not a huge fan for the time being. Instead, I'd encourage retirees to consider a preferred stock exchange-traded fund.
The best part of a preferred stock ETF is that it gives you the best of both worlds. Bond yields are far superior to CDs, but they run the risk of erosion due to rising rates. CDs are safe, and their rates should rise, but their rate of return simply isn't very attractive in real money terms. Preferred ETF yields are on par, or even better than, corporate bond yields, and you'll have the opportunity to take advantage of long-term share price appreciation, which is something you don't have with a corporate bond. Banks are common issuers of preferred stock, and as my Foolish colleague Dan Caplinger discusses below, rising rates could mean healthier returns for banks.
Preferred ETFs also have the safety that retirees would be looking for. They usually exhibit low volatility, which is going to allow retirees to sleep well at night, they receive their dividend payment before common stockholders, and in the event of a bankruptcy, they stand in line below bondholders but ahead of common stockholders for a piece of the pie.
In short, buying a preferred ETF could give you diversity, low volatility, the ability to see your shares appreciate in value, and a well above-average yield. In a rising-rate environment, it could be the best move for retirees.Dan Caplinger: Many retirees rely on traditional fixed-income securities like bank CDs in order to provide the cash flow they need in retirement. Rising rates should be good news for savers, but in actuality, banks typically wait as long as they possibly can before passing on higher interest rates on savings accounts and CDs. Instead, they prefer to raise rates on their lending immediately while keeping deposit account rates low, widening their net interest spreads and improving their profitability.
As a result, rising-rate environments are often a smart time to invest in bank stocks. Obviously, any stock market investment is riskier than an FDIC-insured bank account, but many top-quality banks pay dividend yields that are far higher than what you'll get from any bank CD. The prospect for additional returns on top of that from share-price appreciation is just gravy. In essence, owning stock in a bank allows you to share in the profits generated from those who invest solely in bank savings products, in some ways giving you the best of both worlds. Bank stocks can be risky and shouldn't make up your entire investment portfolio, but putting some of your money into shares of banks rather than leaving it all in bank CDs can be a great way to diversify your investment exposure and take advantage of higher rates more quickly.
