When the Great Recession hit in 2008, it set in motion a chain of events that led to one of the most significant economic downturns in modern history. This downturn was the product of more than two decades of excessive borrowing from which the country has not yet fully recovered. While many continue to suffer, one group was hit especially hard. I am speaking of retirees. We will discuss this in this article and provide five suggestions retirees can do to get through this period.
Background
From 1982 to 2006, the U.S. economy looked more like the roaring twenties than the typical economic expansion. In both periods, the government significantly reduced income tax rates and loan activity was booming. Also for both periods, when the collapse came, it came suddenly. Although some may have benefited financially, most watched in fear as their portfolios melted like an ice cube in an Arizona desert in July. When the dust settled, a new America had emerged that required a paradigm shift. It was time to tighten the belt. In short, interest rates fell and those who were dependent on interest income experienced a sharp pay decrease.
Decrease in Interest
Normally when the economy slows, the Fed lowers interest rates, increases the money supply, and reduces bank reserve requirements. Usually, this is a temporary situation and things return to normal fairly soon. However, the 2008 recession was quite severe. As a result, the typical Fed playbook was ineffective. Why? The chief reason we entered such a severe recession was an excessive use of debt, more specifically, mortgage debt. In essence, the government and the Fed were asking borrowers and lenders to engage in the same activity that led to the recession in the first place and both were extremely reluctant.
Prior to the Great Recession, a retiree with $500,000 in a 5-year CD could earn 5.0%, which generated $25,000 per year ($2,083 per month) in interest income. According to the FDIC, the current average rate on a 5-year CD is only 0.79%, which produces $3,950 per year or $329 per month. Thus, today’s interest is only 16% of the pre-2008 interest on the same investment. Not only has the amount of interest income fallen sharply but inflation has risen. This is a double-edged sword for those who rely on income from their investments. If you are in this situation, here are a few suggestions to consider.
#1) Do Not Lock Your Money Up for a Long Period
Avoid CDs and fixed annuities that require you to lock up your money for more than a year or two. Otherwise, when interest rates rise you may be stuck in a lower interest-bearing security. It is also a good idea to ask if there are any penalties for early withdrawal and get it in writing.
#2) Consider Reducing Expenses
If you are retired and still fairly young, cutting back now might make a huge impact on your future. The worst scenario is taking large withdrawals from an investment that has declined. Reducing expenses now could allow you to increase spending later. Of course, each person has his or her own unique set of circumstances, so this is not a blanket statement for everyone.
#3) Consider Part-Time Work
I realize you have retired. However, if you are able, returning to work even for a brief period (ex: until interest rates return to normal) may be wise. It may also be good for you to get out and meet new people.
#4) Adjust Your Expectations
If you have an investment portfolio, you may need to lower your return expectations a bit. The reason is that, when interest rates rise, bonds and other fixed-income investments will likely under perform. In addition, when interest rates rise to a certain level, it could spell trouble for the stock market as investors sell stocks and buy higher yielding, safer investments such as CDs and bonds.
#5) Consider a Financial Plan
I love a good surprise. However, when it comes to finances, surprises are often unwelcome. A properly prepared financial plan can help you avoid pitfalls and prepare for the future. This makes good financial sense, even if you are already retired.
This is a difficult time for many retirees. It is worse for those who rely on interest income from their investments. Therefore, it is important to understand that you may need to make some temporary adjustments until the economy returns to normal and interest rates rise to their pre-2008 level.
