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What Rising Interest Rates Mean for a Retirement Portfolio

Here’s how to decide if any repositioning is required.

Susan Dziubinski: Hi, I'm Susan Dziubinski for Morningstar. The markets have faced a number of headwinds so far in 2022, including the prospect of rising interest rates. Joining me to discuss what rising rates may mean for your portfolio is Christine Benz. She is Morningstar's director of personal finance and retirement planning.

Hi, Christine. Nice to see you.

Christine Benz: Hi, Susan. Great to see you.

Dziubinski: Let's start out by talking asset class by asset class. Many retirees hold cash, particularly if they follow a bucket strategy. And so, what are we seeing in terms of cash accounts right now, cash yields? What's a fair expectation there?

Benz: Well, they are still really low. We haven't yet seen rising rates or worries over rising rates translate into higher yields on safe accounts like online savings accounts. CD rates have picked up a little bit. You can pick up a slightly higher yield if you're willing to buy a one-year or two-year CD. But generally speaking, savings rates are pretty low, and what we're hearing is that that's because banks and other institutions that take in savings have been flush with cash, that investors have done very well at saving during this period, and so they haven't needed to offer higher yields to compensate investors. I do expect to see higher yields come online at some point in the future, but for now, they're pretty low. I would say be patient. You still do want to hold some cash in your portfolio, and remember that it's there to be your return of capital, not necessarily to provide you with return on capital. Yields are really quite low.

 Then, let's talk a little bit, let's go a little bit further out and talk about bonds. Traditionally, we don't think of bonds as something that's going to hold up terribly well in a rising-rate environment. So, what have we seen on the bond front so far this year?

Benz: Well, about like you'd expect, Susan: We've seen very poor performance across the spectrum of bonds so far in 2022. One thing we've seen is that longer-term bonds, especially high-quality long-term bonds, high-quality Treasuries, for example, have really gotten walloped with the expectation of higher interest rates. We've seen shorter-term bonds hold up relatively better. Lower-quality bonds have actually held up reasonably well through this period as well. So, the longer-term you've been, the more you've seen in terms of red ink in terms of your portfolio losses.

Dziubinski: Let's talk a little bit about the cash versus bond question then. If it's possible that rising interest rates could continue to ding bonds going forward, what's the argument in favor of bonds versus cash today?

Benz: It's a really good question, Susan. I know that investors are thinking a lot about this. And I would say, one key thing is that if you're inclined to just move into cash and not hold any bonds, well, you're probably too late. We've already seen losses in bond funds. But the other thing that I keep in mind is that it makes sense if you're holding bonds at all to match the duration of your bond fund with your anticipated holding period. And if you do that, I think that with bonds you should be able to earn a slightly higher return than you can on cash investments. So, if you have a time horizon of a couple of years, you'll probably outearn cash in a short-term bond fund. If you have a time horizon of about five years, you'll probably outearn short-term bonds with an intermediate-term bond fund. If you have a place for some sort of long-term bonds in your portfolio, you'll probably outearn intermediate-term bonds if you have a holding period of, I would say, 10 years or so. Use that to guide how you invest. Certainly, if you have very near-term expenditures, you probably don't want to hold bonds because of the potential for these short-term principal bobbles that we've seen as we've seen interest rates increase over the past year.

Dziubinski: Let's talk a little bit about the stock market, and it's certainly been a tumultuous past couple of months. And, although I know it's hard to draw a one-to-one correlation, what role has the idea of rising interest rates perhaps played in some of that stock market volatility? Do you think it's been one of the drivers?

Benz: Absolutely. I think it's certainly been a contributor. My personal view is that a bigger contributor has been equity valuations coming into 2022. They were pretty stretched. We've seen growth stocks tumble. They, of course, were the most overvalued coming into this year. Value stocks have held up relatively better. So, I would say, it's been kind of that confluence of events: an overvalued equity market, especially in certain pockets of the equity market, combined with this catalyst in the form of rising yields. So, those have contributed to weak equity market returns so far this year. And incidentally, Susan, it's carried across into non-U.S. stocks as well. We have been anticipating that non-U.S. stocks might perform better than U.S. at some point in time. But where we are in early March here, we really have seen losses equal to U.S. stocks on non-U.S. stocks so far this year.

Dziubinski: Given this backdrop, Christine, and the idea that rates are probably only going to go up, how should investors be thinking about their portfolios today? Should they be looking to make big changes?

Benz: I think it really depends on what you've done with your portfolio over the past few years. I would say if you've been very hands off, you've enjoyed strong equity market gains, that portion of your portfolio has probably grown. It may have grown beyond whatever parameters you set out for it. So, you may want to scale back on stocks in your portfolio even though stocks have already gotten knocked down a bit so far this year. I like the idea of people who are embarking on retirement holding anywhere from five to 10 years' worth of portfolio withdrawals in safer investments--in cash, in bonds. If you haven't gone through that derisking process and you're getting close to retirement or you're already retired, I don't think it's too late to do so. On the other hand, if you just rebalanced your portfolio at the end of 2021, you're probably just fine. You probably don't need to make any further changes to prepare yourself for rising interest rates.

Dziubinski: Christine, thank you for your time today and for your portfolio perspective. We appreciate it.

Benz: Thank you so much, Susan.

Dziubinski: I'm Susan Dziubinski with Morningstar. Thank you for tuning in.