Laguna Niguel, CA

Tuesday, February 14, 2012

With the United States economy struggling to recover from the economic malaise of recent years, The Federal Reserve Board (the Fed) has indicated that it will remain accommodative through the end of 2014.  It intends to keep interest near zero and is willing to accept annual inflation of 2 percent. As with most actions there is both good news and bad news. The good news is that record low interest rates on mortgages allow more people to afford a home and businesses to justify more initiatives as a result of these low rates. The inflation target rate is also an indication that the Fed is concentrating on stimulating the economy.  The bad news is that savers face miniscule returns from their fixed income portfolios for the next few years.  Since retirees have been historically advised to keep a larger percentage of their assets in safe instruments such as Treasuries, certificates of deposit, etc., they are particularly affected by these anemic returns. To further compound the financial dilemma facing retirees is the fact that inflation, the deterioration in the purchasing power of the dollar, exceeds the rates of return that are available from these safe investments.  In other words, they are faced with negative returns on their money.  This means that retirees will need more savings than they would have before the Fed had embarked on this policy.

Since most retirees will rely on a combination of Social Security benefits and the savings that they had accumulated during their working years, safety of principal is as important as the income that their savings will generate. With six month certificates of deposit currently yielding 0.8 percent and five year yielding 2.0 percent, retirees who seek income from such vehicles will incur a 1.2 percent deterioration in the purchasing power from their six month CDs and breakeven with five year CDs. The returns from investments in Treasuries are even more distressing. One year Treasury Bills yield 0.12 percent, 5 year Treasury Notes 0.84 percent, and 10 year Treasury Bonds 2.01 percent.  The real yields on these Treasuries are minus 1.88 percent, minus 1.16 percent and plus 0.01 percent respectively assuming a 2 percent rate of inflation. By way of comparison, from1964 to 2008, six month CDs had an average yield of 6.54% while six month Treasury Bills averaged 5.55 percent, Five year Treasury notes 6.78 percent, and Ten year Treasury Bonds averaged 6.98 percent. (Further details on these historical returns can be found in "A Common Sense Approach to Successful Investing, Utilizing the Power of Stratamentical Analysis)." The impact of current yields on these fixed income investments means that were one to invest his/her money in a six month CD he/she would now need $8.175 to produce the same yield as $1.00 would have historically produced on  such investment vehicles.  If one is approaching retirement age, it is extremely unlikely that he/she could amass 8.175 more retirement funds. 

In order to increase retirement income, retirees must assume more risk from their investments, work longer or spend less during retirement. In reality most retirees are unwilling or unable to work longer and therefore must assume more risk and reduce their living expenses.  According to a report by the New School's Bernard Schwartz Center for Economic Policy Analysis about 36 percent of New York households near retirement had less than $10,000 in liquid assets and about 19 percent had $10,000 to $99,999. This means at current rates a 6 month CD would produce $80 to $99.99 per year.  One could certainly not live a lavish retirement lifestyle in New York or for that matter anywhere in the United States.

What are the conclusions that one should reach from this depressing information?

• First and foremost is the need to start saving for retirement early in your life.  The longer your investment timeframe the more likely you will be able to achieve your retirement objectives

• Don't incur undo risks. While we all want to invest in the next Apple, Google etc., it is exceedingly difficult to such opportunities.  Instead, a well diversified portfolio offers the best chance of appreciation of your assets.

• Beware of hyped investments. Prevailing wisdom is often wrong. Internet stocks once soared only to crash.  Real estate that only goes up produced, in part, the recent recession. Gold that is constantly being promoted on television will in all probability prove itself to not being a wise investment.

• Anticipate your income needs. Prepare a budget of monthly sources and uses of retirement funds.  Align your investments so that they will provide you with the necessary income. ("For further details refer to Common Sense Prescriptions for Financial Health, Improving Your Quaestrology)."

• Do not delegate investment decisions to others. While many of us will need to consult with financial advisors, it is important to remember that you and not that advisor will bear the consequences of investments made on your behalf.

About the Author

Experienced as a registered representative, an individual investor and a management consultant to Fortune 500 companies, Doniger has developed his perspectives on the economy from a lifetime of smart investments. His books include A Common Sense Road Map to Uncommon Wealth, A Common Sense Approach to Successful Investing and Common Sense Prescriptions for Financial Health. He is also a regular guest on the Business Talk Radio Network, CNBC, CDTV.net and other shows. His articles have been published in media outlets such as Investor's Digest of Canada and Morningstar.

Marvin H. Doniger

Doniger Associates

Laguna Niguel, CA

949-661-5456

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