By Jacqueline Baratta
Jacqueline Baratta is an undergraduate student majoring in Accounting in the Eli Broad School of Business at Michigan State University.
Due to the low interest rate environment, retirees are changing their safe investment focus to add more risk to their investments in order to obtain greater yields by investing their money into stocks, lower rated bonds that offer a higher interest rate and alternative income vehicles.
Currently the dividend yield of the S&P 500, available to investors through ETFs such as Vanguard S&P 500 ETF (Symbol: VOO) or through Vanguard 500 Index Fund (SYMBOL: VFINX) is only about 1.92% as of March 17, 2017. This compares with the current rate on the 10-year Treasury Note is only 2.501% as of March 17, 2017.
This current differential reflects that money has flowed from US Government Bills and Notes and into the stock market over the years causing the stock dividend yield to be reduced. The reversal in the yield differential of the two investments are causing retirees to seek other income producing assets to achieve their retirement income objectives.
Retirees are instead allocating investment funds to high yielding utility stocks, such as Entergy (SYMBOL: ETR), which currently pays about 4.5% or to Duke Energy (SYMBOL: DUK) paying about a 4.1% dividend yield. Alternatively, high yield, or junk, bond funds such as the Fidelity Capital & Income Fund (SYMBOL: FAGIX) pays about 4% at present. Master limited partnerships such as Energy Transfer Equity (SYMBOL: ETE) pay yields about 6%, but at significantly higher risk.
Income from CDs cannot pay the bills
Retirees typically invest a large portion of their retirement savings in order to generate income during their retirement years. In the mid-1980s certificates of deposit yielded more than 11% on a one-year CD. At that time, safe investments, for example CDs and Treasury bonds or notes, allowed retirees to receive a high rate of return without having to put their money into risky investments like the stock market which is subject to the market changes.
Today, record low interest rates hovering around 1.3% for a 1 year CD has made it cheaper to take out a loan, but in return causes an individual to receive a lower return on their retirement savings accounts. According to Jason Fichtner, Senior Research fellow form Mercatus center at George Mason University,
"Low interest rates translate to lower yields on fixed income assets, meaning the monthly interest and dividend payments that seniors rely on in retirement will generally be lower than anticipated. Low interest rates also negatively impact Social Security's broader finances because Social Security Trust Funds earn interest on their US Treasury bond holdings."
The 1.30% return on a 1 year CD does not allow one to grow their earnings in excess of the inflation. The inflation rate as of January 2017 is 2.5%. Most savings accounts offered by CIT bank and Capital One Bank will not provide a better offer than 1.5%. Banks that offer relatively higher rates tend to have usage requirements, a minimum balance, savings requirements, and other rules that impact the withdrawal of saving for living expenses.
Early in a workers' career they invest their retirement savings in growth oriented investments to increase the amount of their savings. Along with the enhanced growth comes enhanced risk of market changes. The stock market has provided a higher return than interest bearing investments.
Younger workers have time to generate additional savings during an economic downturn before they need to withdraw savings to cover living expenses. Retirees typically do not have the ability to replace lost savings with earnings from working. Thus, retirees typically focus on income safety and accept a lower return for their savings.
Retirees today are required to adjust their investment strategy and be more aware of market changes. The risk-free investments where they were getting satisfactory returns in bonds and notes are no longer available for the time being. The Retiree's will be required to be aware of alternative investment strategies using high yielding stocks, mutual funds with a stock component and master limited partnerships to derive a reasonable return.
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Parker, Tim. "Should I Invest in Stocks During My Retirement?" Investopedia. N.p., 30 Jan. 2017. Web. 07 Apr. 2017. <www.investopedia.com/articles/personal-f...;.
"What Is The Average Dividend Yield of the Stock Market?" What Is The Average Dividend Yield of the Stock Market? Zacks, 30 Jan. 2013. Web. 07 Apr. 2017. <finance.zacks.com/average-dividend-yield...;.
Gustke, Constance. "ETF Alternatives To Money Market Funds." Bankrate. N.p., n.d. Web. 10 Apr. 2017. <www.bankrate.com/investing/etf-alternati...;.