On September 18th, 2019, Jerome Powell, the current chair of the Federal Reserve, announced the second federal rate cut for the year. An additional 25 basis points, or .25%, to put the federal rate between 1.75% and 2%. So, what rate is he talking about? How does it affect retirees?
What Is A Federal Rate Cut?
In short, the “Federal Funds Rate” is the interest rate that large banks charge each other when lending money for short periods of time. This rate, in turn, affects everyday rates that consumers are more used to seeing like mortgage rates, bond rates, or even the rate seen on savings accounts.
The above chart shows the clear relationship between the Federal Funds Rate and mortgage rates. The two orange arrows show rate cut announcements by Powell, and the mortgage rates drop immediately after.
Why Did The Fed Announce A Second Rate Cut?
The Fed uses rate cuts as a tool to stimulate the economy. The theory is that when interest rates are lower, consumers can borrow money for cheaper, and, in turn, they will spend that money to help drive the economy.
In his speech on September 18th, Powell said, “the global growth outlook has weakened, notably in Europe and China. Additionally, a number of geopolitical risks, including Brexit, remain unresolved. Trade policy tensions have waxed and waned, and elevated uncertainty is weighing on us investment and exports.” The Fed may be expecting an economic downturn and hoping that by lowering the rate, they can postpone or soften the blow of a recession.
What Does This Mean For Retirees?
These rate cuts and future economic expectations have big implications for retirees. First, retirees should be careful with having money at risk in brokerage accounts. Someone with a million dollars in the S&P 500 on October 8th, 2007 would have had around $437,559 on March 2nd 2009. This could devastate a retirement plan, and if that person needed to take income from their account in March 2009, that money would most likely have never had the opportunity to recover.
Second, bonds may not be the retirement safe haven they have been in the past. Historically, retirees were able to earn decent returns of 6% or more in “safe” AAA bonds. Today, Moody’s states the current “Seasoned AAA Corporate Bond” yield is 3.02%. According to Moody’s, the long term average for these same bonds is 6.82%. If a retiree were to put a significant portion of their retirement into bonds today, they would see that as interest rates rise, the value of their investment decreases.
What Should Retirees Do?
It’s not time for retirees to despair and hide all their money in a .01% FDIC insured savings account. It’s time for them to talk to a financial fiduciary advisor, who can show them all the options available to them. There are more options to retirees than locking up funds in an income annuity or staying with the status quo and taking the risk with bonds and bond funds.
Warren Buffet said, “Too often, a vast collection of possessions ends up possessing its owner.” Don’t let fear make decisions for you. In a proactive effort, you can leave what was chosen for you by a limited list of options and find what is best suited for you and your retirement.