Retirees don’t have it easy these days. Inflation is high, and the stock market is volatile. Investment income, which is probably the most important part of retirement planning, is under attack. Retirees need to understand what’s happening and what it means for their retirement plan.
Yields are shrinking
The entire landscape for income investments has changed. The shift is quantifiable, it’s huge, and it impacts retirees more than other investors. Yields across capital markets are near all-time lows. You can still find some attractive yields if you look hard enough, but the overall trend is undeniable — and it’s infecting numerous asset classes.
This chart shows the distribution yields for four different ETFs:
iShares Barclays 7-10 Year Treasury Bond Fund (NASDAQ: IEF)
SPDR S&P 500 (NYSEMKT: SPY)
iShares Intermediate-Term Corporate Bond ETF (NASDAQ: IGIB)
iShares S&P National Municipal Bond (NYSEMKT: MUB)
They come together in a common narrative for various types of investments. Bonds have exceptionally low yields today, whether they are issued by corporations, local governments, or the federal government. Interest rates have been tracking downward for decades, and the central bank response to the COVID-19 economic crisis sent rates tumbling to their current level.
This has also trickled into dividends. The S&P 500 dividend yield is around 1.2%, which is just about an all-time low that’s only rivaled by the dot-com bubble. Some of that is due to the rising influence of megacap tech stocks in market indexes, because those stocks don’t pay dividends. However, yields are even being compressed in many reliable dividend stocks. Some stocks and dividend ETFs are certainly keeping their distribution yields relatively high, but they are exceptions rather than the norm.
The ETFs in the chart aren’t distributing as much to shareholders because their holdings aren’t producing as much cash flow. Investment portfolios are producing less income than almost any point in recent history.
Why yield matters
Yield dictates returns for income investors. Growth investors can always theoretically pick the next Amazon, but there’s more of a cap on income strategies.
There’s a clear trade-off between yield and risk. If you want to achieve higher yields, you have to accept an increased likelihood of something catastrophic happening. High-yield bonds carry additional default risk. High dividend yields are signals that the market expects a company to reduce its distributions.
It’s not responsible for investors to fill their portfolios with risky securities. In fact, they should probably be ignored altogether. You want to reduce volatility and big losses. Years of hard work can be destroyed by investment plans that are needlessly aggressive.
In short: Retirees are stuck with the current low-yield situation.
What this means for retirees
This all translates to lower retirement income. Social Security is an important source of cash flow for seniors, but it’s not enough for most people. Retirement planners are facing a major challenge trying to bridge the gap.
The principles of retirement planning haven’t changed, but the numbers have — and these numbers are directly connected to real-life activities. If yields get cut in half, your assets will only produce half as much buying power as they used to. This is why many financial planners are giving up on the 4% rule for their clients. Investors with $1 million in their 401(k) could safely distribute $40,000 from their retirement accounts in previous years. That’s closer to $30,000 now.
Unfortunately, retirees have limited options to overcome the low-yield situation. The rest of us need to think about ways to safeguard ourselves from these risks when we eventually stop working. Ultimately, a bigger pool of assets translates to more income in retirement.
If you develop enough savings, low yields would still kick off a decent amount of cash. Consider some strategies to improve your savings rate, responsibly invest for growth, and make sure to minimize taxes where you can.
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