Your retirement vs. low interest rates

Low interest rates may be the most devastating thing to happen to the generation now approaching retirement. After all, the stock market has more or less recovered from the steep losses of 2008 and 2009, while bank rates and bond yields have just gotten worse.

In the past, a common goal of retirement saving was to build a portfolio that would generate enough income live off of, perhaps when supplemented by Social Security. The drop in bank rates has made that goal almost impossible for most Americans. Historically, a typical CD rate of 5 or 6 percent would generate $50,000 or $60,000 of annual income on savings of a million dollars. Now, with short-term CD rates down to 0.17 percent, a million dollars would generate just $1,700 in annual income.


When even millionaires can't generate enough retirement income to pay for more than a month or two of rent, it's time to take a different approach to retirement saving. Here are some guidelines for adjusting your retirement savings plan to today's interest rate environment.

1. Take a total return approach

Use a combination of income and investment gains when you start withdrawing from your portfolio, rather than counting solely on income. This is necessary because interest rates will no longer give you very much income, and because bank rates and even many bond yields are running below the rate of inflation. If you are going to keep up with rising prices, you will need to have a growth component to your portfolio.

2. Expect a lower withdrawal percentage

CD rates of 5 or 6 percent are gone, and this means it may not be sustainable to withdraw that much of your portfolio every year. A total return approach will allow you to withdraw more than your portfolio generates in income, but try to keep it less than 4 percent a year. There's no easy way to approach living with a lower withdrawal percentage. It either means saving more, or living on less in retirement.

3. Shorten bond durations

Duration is a measure of the effective length of the debt obligations you own. It's partly determined by a bond's maturity, but the income stream is also a factor. Now might be a good time to shorten bond durations in your portfolio. For one thing, the steady drop in bond yields in recent years has effectively lengthened the durations of bonds in general, so shortening up is one way to adjust for that. For another thing, the extreme low level of yields leaves bonds very vulnerable to price declines due to rising interest rates.

4. Limit volatility

Even though income-oriented investments may play a smaller role in your portfolio, don't be tempted to go overboard into riskier investments. Withdrawing money can compound the damage from portfolio declines, so you will want to limit the volatility of your portfolio once you start taking money out.

5. Be prepared to adjust on the fly

This is no time for an auto-pilot approach. Since there is less certainty to total return than to income, be prepared to adjust your income target and asset allocation from one year to the next.

With even high-yield savings accounts yielding less than 1 percent, the deck is stacked against American savers today. But with some common sense and flexibility, you can adapt your retirement approach to this more challenging situation.

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