What Rising Rates Mean for Retirees

Jeremy Glaser: For Morningstar, I'm Jeremy Glaser. With the yield on the 10-year Treasury exceeding 3% again, many retirees might wonder what it means for them and their portfolios. I'm here today with Christine Benz, she is our director of personal finance, for her take.

Christine, thanks for joining me.

Christine Benz: Jeremy, great to be here.

Glaser: I thought maybe we could tackle this asset class by asset class, see how they'd be impacted by higher rates. The first is cash. What are we seeing in terms of yield on cash accounts right now?

Benz: That is one silver lining. Investors have seen a little bit of volatility in their long-term assets, which I know we are going to discuss, but if you are a cash investor, if you are a retired person and you are holding some assets aside in true cash investments because you want to hold them to meet your ongoing living expenses, cash yields are a lot more attractive than they were a year or two ago. My advice is that people should get serious about wringing as much as they possibly can out of their cash accounts, shop around, revisit this if they haven't for a while.

A couple of years ago, it was hard to get excited about making 0.5% versus 0.2%. Now, you don't have to look too hard to find online savings account, FDIC-insured investments that are paying 1.75% or more. So, shop around. Be careful if you have brokerage sweep accounts. Those have notoriously low yields attached to them. Keep the bear minimum in your brokerage accounts, try to get that money out and invested in the highest-yielding option that you can find.

Glaser: What about money markets?

Benz: Money market mutual funds are not FDIC-insured, so that stirs up a lot of confusion. Banks offer what are called money market accounts that are FDIC-insured. If you are looking to a mutual fund, there might be a convenience factor to have those assets side-by-side with your other long-term mutual fund assets. Just bear in mind that you do not have a guarantee associated with those investments. But there are relatively new restrictions that have gone into effect for money market mutual funds. They are safer than they were in the past. They need to have more liquidity in their portfolios. They need to focus on higher credit quality. The landscape is safer for money market mutual fund investors, but they are not guaranteed investments.

Glaser: Let's talk about bonds. Traditionally, we think of bonds not holding up particularly well in a rising rate environment. Has that been true so far this year?

Benz: Absolutely. If we look at the core intermediate-term bond products that a lot of investors hold in their portfolios, year to date, they are looking at losses of 2%, 3% in some cases, which certainly is more loss than most investors want in their bond funds. But we have seen a gradation among bond funds. Certainly, the short-term and the ultrashort-term investments have held up quite well, whereas the long-term funds, especially, the long-term government funds, have really borne the brunt of some of the interest-rate-related volatility that we've seen so far this year.

Investors need to mind their time horizons when determining which types of bonds to hold, which types of bond funds to hold. If they have very short-term income needs from their portfolio, my bias would be to keep that money in short-term bond funds or even in cash.

Glaser: Let's talk about decision between holding cash and bonds. If I can get 1.75% in those online savings accounts, why should I hold bonds at all?

Benz: It's a really good question, Jeremy. I think it does come down to time horizon. If you are a bond investor and you have a time horizon of, say, five years or longer, I think it's safe to say that you will earn a higher return over that time horizon than you are likely to earn in your cash investments, but you will have more principal-related volatility. If that makes you uncomfortable, well, then you can stick with cash and short-term bond funds. Just know that you probably will lag an intermediate-term portfolio over a longer time horizon.

Glaser: Speaking of volatility, it's been a tumultuous couple of months for the stock market. What impact do you think that these changes in interest rates are having on the stock market? I know it's hard to draw one-to-one correlation there, but do you think that's been one of the big drivers of the volatility?

Benz: Potentially so. My personal view is that equity market valuations have probably been the biggest catalysts for some of the volatility that we've seen recently, that a lot of the good news that we've seen in terms of corporate earnings is already priced into equities currently. That's just my view of why we've seen some volatility. But certainly, when we look at the equity investments that investors look to specifically for income, we've seen them perform particularly poorly. I would point out REITs and real estate investment funds have struggled. That's partly because I think investors see, while these higher safe yields are coming online in bonds, do I really need to reach into this equity for that yield? A lot of times investors do look to real estate investment trusts to supply income as well as potentially some appreciation.

Glaser: Big picture though, do you think that there is any need to radically change your retirement plan based on the rising rates we've seen this year?

Benz: Probably not, but I would say that investors should revisit their asset allocations and compare them to their plans. The hands-off investor, even if he or she hasn't been actively adding to equities over the past few years, has seen an ever-larger equity position. One argument I've been making for a while is that retirees have a great source of cash flow hiding in plain sight in terms of their appreciated equity positions. It's a great time to look at your asset allocation mix. If you decide that you are too heavy in stocks relative to where you want to be, you could potentially strip back your highly appreciated equity positions, maybe look particularly to the growth column of the style box, sell some of those appreciated winners, refill your cash bucket and perhaps give yourself a nice cushion for the next couple of years that you'll hold in cash investments.

Glaser: Christine, thank you.

Benz: Jeremy, thank you.

Glaser: For Morningstar, I'm Jeremy Glaser. Thanks for watching.