Low CD Rates Mean Risky Business
Interest rates continue to fall in the midst of already-low CD rates and savings yields, and it's getting more difficult for those living on a fixed income to depend on CDs as a main source. We asked K. Steven Lovell, lecturer of economics and finance at University of Texas Pan American, for his viewpoint on what seniors can do to improve their financial outlook in a low-yield economy.
Lovell says seniors can add a little more risk to their portfolios without spreading their investments too thin and describes why financial education should be a priority.
The Federal Reserve has pledged to keep the federal funds rate at or near zero percent until mid-2013. What should senior citizens and others living on a fixed income do amid low CD rates?
Seniors need to take more of a portfolio position with regard to saving. The days where you could ladder CDs and keep up with inflation are over. Seniors need to include various kinds of investments including dividend-paying stocks, junk bonds, laddered bonds, foreign bonds and dividend stocks.
How can they cope with low savings yields without taking on too much investment risk?
Many seniors are too risk-adverse. I'm not saying they should give up their laddered CDs altogether, but depending on their net worth, adding some risk to their portfolios is advisable. A recent study regarding low-volatility stocks, by Malcolm Baker of Harvard University and Jeffrey Wurgler of New York University in the Financial Analysts Journal, shows low-volatility stocks are less risky and have a higher return than the overall market. Even though your portfolio has high-risk components, the portfolio as a whole is actually less risky -- especially if you use a buy-and-hold strategy.
The financial world has become much too complicated to invest on your own unless you dedicate a lot of time and education to learning. Seniors need to seek professionals who can help them. Unfortunately, that can also create some problems. We have many nonprofit and charitable organizations that help people after they have lost their money or are in or near bankruptcy. But there are few of these organizations that develop the expertise and license to guide the lower and middle class seeking retirement guidance. Local, state and federal governments, as well as charitable institutions, need to understand many individuals and families don't have the sufficient savings to justify financial planners. That leaves them on their own without the education or tools needed to make proper decisions. Yes, there are a lot of tools and information available on the Internet. But even if you have access, the information is often contradictory or self-serving to the people who post it. Also, how do you sort the good information from the bad unless you have the knowledge to determine which is which? Unless we as a country start to address these issues, more and more retirees will lose their current standard of living and become increasingly dependent on Social Security due to bad financial decisions made out of desperation and/or ignorance.
We would like to thank K. Steven Lovell, lecturer in the Department of Economics and Finance at University of Texas Pan American, for offering his insights, and Greg McBride, CFA, senior financial analyst for Bankrate.com, for contributing the questions for this interview.