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A warning to seniors if the Fed lowers interest rates

Key Points
  • The Federal Reserve is expected to cut interest rates even further this month, which doesn’t bode well for CDs and interest-bearing savings accounts.
  • Retirees should be cautious about chasing yield to keep up with the cost of retirement.
  • Now is the time to reevaluate your holdings and determine whether you have enough of a cash buffer to get through a downturn.
Thomas Barwick | Taxi | Getty Images

The prospect of lower interest rates may put retirees in a bind: Contend with less growth on their "safe money" or consider taking more equity risk.

The Federal Reserve is expected to lower the federal funds rate — the key interest rate banks charge to lend to each other money — at the end of July. Currently, the rate is 2.25%-2.5%.

Borrowers and savers have been keeping an eye on the Fed's movements.

A rate cut would lead to lower interest costs for people with variable rate loans. It likely would also reduce the interest credited to savings accounts.

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Currently, online savings accounts are offering annual percentage yields as high as 2.5%.

The possibility of having those rates reduced is a scary one for retirees: It may nudge them into chasing returns to sustain their standard of living.

"Every time they lower the rate, it makes people want to shift more aggressive," said Jeffrey Levine, CPA and CEO of BluePrint Wealth Alliance in Garden City, New York.

"Retirees who have taken more risk got away with it due to the long bull market, but when will it catch up?" he said. "Because at some point it has to."

A 10-year run

Major market indexes have climbed sharply since reaching a post-recession nadir on March 9, 2009.

However, some advisors are less than upbeat; they think an economic decline might be around the corner.

"The stock market has been hitting all-time highs, but the reason we're facing lower interest rates is slowing down and we're heading toward a recession," said Leon LaBrecque, certified financial planner and chief growth officer at Sequoia Financial Group in Troy, Michigan.

He noted that the yield curve had inverted earlier this year, meaning rates on short-term Treasurys were higher than rates on long-term Treasurys.

Essentially this means investors holding longer-term U.S. debt are being compensated less compared to those holding shorter-term issues.

Investors and economists interpret a yield curve inversion as a sign of an approaching recession.

Reassessing risk

Monkey Business Images | Getty Images

Advisors working with retirees and near-retirees are discouraging them from chasing riskier returns.

However, they are asking investors to think deeply about their ability to withstand a period of low interest rates and a market upheaval.

"Clients who are worried about stock market implosions may benefit from modifying their portfolio so that they don't have more than the appropriate amount of exposure to equities," said Vance Barse, a wealth strategist at Manning Wealth Management in San Diego.

He's addressing this by having clients complete a semi-annual risk tolerance questionnaire.

Retirees who have taken more risk got away with it due to the long bull market, but when will it catch up? Because at some point it has to.
Jeffrey Levine
CPA and CEO of BluePrint Wealth Alliance

Retirees should also consider the purpose of the "safe money" they keep in money market funds and savings accounts.

"The conservative part of the portfolio is there to provide some diversification and buffer — it's a low bogey," said Randall S. Lee, a CFP and partner at TrustCore Financial Services in Brentwood, Tennessee.

"The coaching I've had to do with clients is to help them understand that their bogey isn't the S&P 500," he said. "You should be trying to make the rate of return you need to earn in your retirement plan.

"If you're hitting it, you're solid."

Seek yield responsibly

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Advisors are recommending that their retired clients keep three to five years' worth of expenses in cash and cash-like instruments, including money market funds and Treasurys.

"Retirees should consider how to weather the storm safely, like maybe building a ladder of CDs to last two to three years or through a possible downturn," said LaBrecque of Sequoia Financial Group.

Top rates on three-year CDs are currently about 3%, according to Bankrate.com.

Older investors are also turning toward online banks that offer higher yields, said Lee of TrustCore.

Rates are as high as 2.5% at a handful of web-based banks, while the average savings account interest rate is about 0.1%, according to Bankrate.com.

"A 2% bank deposit sounds paltry if we consider what interest rates were before the financial crisis," Lee said. "But with inflation still low, these low-risk assets are earning a real return."

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