By Mark Miller
CHICAGO Dec 18If you are still wondering
whether we are in a "new normal" investment climate of ultra-low
interest rates, wonder no more: Federal Reserve Chairman Ben
Bernanke settled any lingering doubts last week when he
guaranteed rates will stay near zero at least through the middle
of 2015 -- or until the jobless rate falls to at least 6.5
percent, or the inflation rate jumps above 2.5 percent.
Bernanke's unprecedented announcement(see)
might be good for the economy, but it is bad news for retirees,
who already have suffered through four years of historically-low
Ultra-low interest rates have inflicted all manner of pain
Insurance companies have raised the price of annuities and
long-term care policies as a result of low returns on
bond-oriented investment portfolios. Pension plans have had
trouble meeting their investment objectives, forcing them to
reduce their funded ratios and creating political and fiscal
havoc for plan sponsors.
The most direct problem facing retirees, however, is how to
generate income from retirement savings. The traditional
reliance on low-risk bonds and certificates of deposit just does
not work in this rate environment, and higher-yielding products
come with unattractive levels of risk.
However, now that we know the "new normal" is here to stay
for at least a few more years, there are several low-risk
options for retirees, and people who expect to retire soon, and
a low-risk option is by far the best approach one can take in
uncertain times .
1. Delay retirement
It's not possible for everyone, but working a few additional
years can boost retirement income in several important ways.
First, it allows you to delay filing for Social Security,
adding roughly eight percent annually to monthly payments when
you do finally file. Think of this as "buying" a higher annuity
amount from Social Security; the "cost" is the amount you spend
from current income on living expense in lieu of Social Security
payments. Delayed Social Security filing makes sense as an
income-booster even if it means drawing down your nest egg in
the early years of retirement for living expenses.
If you are able to work longer, it means fewer years of
living on your retirement nest egg, and one hopes more years of
contributions -- and investment returns -- from your 401(k) or
2. Adjust spending
A new normal for low-risk return implies a new normal for
spending, says Michael Kitces, partner and director of research
for Maryland-based Pinnacle Advisory Group.
"We often talk with our clients about re-evaluating this.
How many vacations do they really need to take? Should they
reevaluate where they live? Moving from an expensive
metropolitan area to a less expensive suburban or rural area
could reduce their monthly costs or free up a great deal of
equity that can be used to reduce or eliminate a mortgage."
In the best of all circumstances, it would allow a person to
enter retirement debt-free.
3. Focus on investment expense
In a low-return climate, it's more important than ever to
control factors that you can control -- and investment fees are
a prime example. Low-cost passive index funds offer a great way
to do just that, Kitces notes.
"The good news is that we're seeing a lot of investment
management companies duking it out aggressively to bring costs
down, so it's a consumer-friendly environment. There's plenty of
opportunity to really manage costs lower and lower," he says.
That's been the market direction for some time now, as the
November Lipper FundFlows Insight Report shows. Diversified
equity funds showed their 19th consecutive month of net
redemptions, while low-cost index and exchange-traded funds saw
growth. Bond funds also enjoyed strong growth.
4. Go alternative
If you're comfortable taking substantially more risk,
consider alternative investments that aim to generate higher
return. One approach is through mutual funds that invest in a
mix of high-yield bonds, dividend-oriented stocks, emerging
markets or mortgage-backed securities.
For example, the JPMorgan Income Builder Fund aims
for a high yield with a blend of high-yield bonds,
income-oriented equities, emerging market investments and
"non-agency mortgages" -- mortgage-backed securities that are
not backed by a federal agency, including subprime and jumbo
loans. The fund's three-year annualized return is 9.82 percent
as of November 30, 2012.
"The challenge is how to get a good trade-off between risk
and income," says Michael Schoenhaut who manages the fund. "When
we do get higher yield, we're being paid to take more risk."
But an alternative fund should not be more than a small
slice of the portfolio mix for pre-retirees, or anyone already
retired, he cautions. "For retirees, we'd combine this with
other assets to bring down risk."
And seniors should stay away from privately-offered,
unregulated "alternatives" for deals such as construction loans
or real estate developments that often are pitched as
replacements for traditional yield products. "There really is no
free lunch," Kitces says. "If it sounds too good to be true, it
5. Go long
Investing in bonds with longer maturities will bring higher
yields. The risk here, of course, is that a jump in interest
rates will tear into the principal on your bond investments.
Even though Mr. Bernanke has assured us rates will stay where
they are, that will not be any comfort for the risk you'd need
to take to get higher return.
Says Kitces: "It's one thing to say this is how it's going
to be for a few years, but that doesn't mean you'll be happy
holding bonds maturing in the 2020s or 2030s."