The Federal Reserve has just extended its low interest-rate policy through the end of 2014. The central bank was widely praised for its extraordinary commitment to helping the economy recover.
But there was little, if any, cheering from investors and retirement experts who are looking at nearly three more years of dismal yields on bonds, CDS, and savings accounts.
As well-known investment economist and adviser Burton Malkiel told U.S. News, the world of safe investing is turned upside down when the yield on AT&T's stock dividend is 6 percent, while its bonds are yielding only 3 percent. Malkiel, and many others, are jumping ship on long-held advice for investors to include lots of bonds in their retirement portfolios as they age.
Stephen Utkus, head of retirement research at Vanguard, notes that many bond investors fared very well last year as already-low interest rates declined even further. Because the prices of existing bonds rise as interest rates fall, many bond investors saw double-digit returns in 2011.
But with little, if any, room for continued declines in interest rates, the odds of appreciating bond prices are small. The Fed's commitment to maintain low interest rates may reduce some bond investors' fears of falling prices, but it does not create the conditions for making money. Learning to live with 3 percent bond yields looks like the new normal for fixed-income investors.
Even scarier is Utkus' view of where future retirement funds will come from: "The bulk of long-term wealth accumulation over the next decade is likely to come from what you save, not what you earn."
Fidelity Investments recently polled five of its fixed-income investment fund managers. Some of their strategies are not for the faint of heart. If investors want higher yields, they will need to take more risks. For example, Fidelity sees opportunities in lower-rated bonds from companies and municipalities. This is not a space for novices, however, but for experienced investors.
And remember those much-maligned mortgage-backed securities? They helped destroy markets a few short years ago. Today, Bill Irving, manager of the Fidelity Government Income Fund, likes them. But as he notes, there are more than a million different securities tied to the mortgage industry, so investors should seek advisers familiar with this sector.
Irving also advocates owning some U.S. Treasury securities, preferably in the form of Treasury Inflation Protected Securities, or TIPS. The primary goal with TIPS is not to make money, but to have security in case the sky falls in Europe or elsewhere in the world.
More broadly, his view for savers is bleak. "Savers are likely to get lousy returns, even negative returns, after inflation and taxes, for a long time," Irving said in a recent client newsletter. "Because yields are so low, we don't see a lot of long-term value in the government bond market."
Low interest rates have also changed the landscape for annuities, another traditional staple of safe retirement investing. Moshe Milevsky is an annuity expert who teaches finance at York University in Toronto. Normally, he advocates that investors convert some of their nest eggs into income annuities that will provide them guaranteed income payments for the rest of their lives.
Such annuities are often recommended by financial advisers to augment Social Security and any pensions to pay fixed living expenses. Once those basics are funded, investors can then manage their other investments to generate income for discretionary retirement expenses such as travel and entertainment.
Today, however, low interest rates have caused insurance companies to offer payment promises on immediate annuities that are very unattractive, Milevsky says. And this situation could last for years. In a world of few good options, he says people might consider a variable annuity (VA) with a guaranteed payment.
VAs allow owners to place their investments in mutual funds, so VAs could provide better returns if securities prices rise. But if they don't, the payment guarantees act as an insurance policy by providing downside protection. VAs often carry complex fee and redemption rules and require careful study and usually, the guidance of an experienced adviser.
Beyond seeking dividend income and modest returns on fixed-income securities, investors should see if they can pay off more expensive credit-card debts. Also, with mortgage rates at all-time lows, home refinancing may make sense.
Finally, investors should spend time this year thinking about how the tax treatment of their investments might change. Once again, the Bush-era tax cuts are set to expire at the end of 2012. This would trigger higher income-tax rates and steeper taxes on capital gains and dividends. Extending the cuts would require a new law.
Now, it is at least theoretically possible that a government facing years of trillion-dollar deficits will decide to renew these lower tax rates. But investors should understand how their portfolios would fare in a higher-tax world, and determine if any precautionary investment shifts make sense.