It isn’t a very good time for retirees seeking income from their investments. Rates have been at near historic lows for several years.
U.S. Treasury Bonds have been paying a paltry sum. Savings vehicles like FDIC-insured certificates of deposit are no better. And while dividend-paying stocks have their place in a diversified portfolio, they come with added risk and could lose value. The Fed is also considering reducing its $85 billion a month in bond purchases, which means the value of existing bonds could decline as interest rates rise.
What options do those seeking income have in such uncertain times? Here are several things investors can do to protect their portfolio:
Don’t panic. So far this month investors have yanked $20 billion from bond mutual funds and ETFs. The herd mentality has taken hold. While a lot is at stake, particularly for retirees in need of steady income, heading for the exits in an effort to time the market is a mistake. Many people tried the same thing a couple years ago when 10-year Treasuries were at 3 percent, only to watch rates tumble further.
Limit interest rate risk. There are other ways to reduce the risk of rising interest rates besides exiting bonds completely. One option is to stick with shorter-term bonds that expose investors to less risk of rising rates. Another option is to invest in bonds that rise with inflation, such as TIPS and I Bonds. I regularly invest the $10,000 annual limit in I Bonds on behalf of my wife and me. There is also no state or local taxes on the interest earned on I Bonds, and you can defer the federal tax until you sell the bonds or they mature in 30 years.
Think twice about long-term CDs. Certificates of deposit have been a mainstay of retirement income, but interest rates aren’t that attractive right now. Shorter-term CDs and even some savings accounts return 1 percent or more. While not a princely sum, I’d wait to buy longer-term CDs until we better understand when interest rates will rise. If you must invest in a CD this year, consider no-penalty and rising rate CDs, both of which can protect you from an interest rate spike.
Stay the course. Stocks may also be in for a bumpy ride. This year at the annual Berkshire Hathaway shareholder meeting, Warren Buffett compared the effect interest rates have on stock values to the effect gravity had on Sir Isaac Newton’s apple: The higher the rates, the lower the value of stocks. We’ve already seen the market decline based on the belief that the Fed will scale back its bond purchases. Prepare mentally for this bumpy ride so you don’t try to jump out of the market when things get a bit dicey.