Rewind a few years, and investors seeking income had to get a bit more risky thanks to a low interest rate environment brought on by the Great Recession of 2008 and 2009. But with the Federal Reserve hiking interest rates this year and more short-term rate increases expected, income-seeking investors will have an easier time of it.
"Short-term interest rates going up will lead to more attractive yields and returns on cash bank accounts," said Rob Williams, director of income planning at Charles Schwab, in a recent interview with Investopedia. "That's a great thing for retirees who weren't getting much of a return on their short-term investments."
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Heading into 2018, most investors and market watchers expected the Federal Reserve to raise interest rates as concerns about a rise in inflation ticked up. With the Fed aiming to bring rates to a more normal level, it took action. So far, the Fed has delivered twice this year, and the expectation is that one or two more short-term rate hikes are in the cards for 2018. The Fed could also move to raise short-term interest rates three more times in 2019, up from the previous expectation of two rate hikes next year.
While the Federal Reserve's actions signal the maturing of the economic cycle, they also mean that investors will receive a higher return on savings accounts, certificates of deposit and short-term bonds, something that many retirees haven't seen for some years now.
Because interest rates have been low for so long, cash investments such as savings accounts and CDs weren't an option for income-seeking investors. With little yield to come by, income investors got into more risky areas of the market such as dividend-paying stocks, real estate investment trusts (REITs) and high-yield bonds. While those areas have the potential to give them a higher return, the risk is also elevated, which is a recipe for disaster for retirees. After all, they don't have years left to make back money lost on risky investments. Instead, they are in the drawdown phase of their life and need a steady stream of income.
With short-term interest rates moving higher, Schwab's Williams said that it could be a good time for investors, particularly retirees, to pore over their portfolio and scale back some of their risk. For investors who are holding positions in higher-paying dividend stocks such as utilities and REITs, the executive at The Charles Schwab Corporation (SCHW) said that those investments could be more sensitive to interest rates hikes and react negatively when rates move higher. That makes short-term bonds more attractive to retiree investors who may want to move money out of REITs and utilities and back into bonds. According to Williams, REITs have been underperforming as rates have been rising.
Williams warned that investors staying the course with their high-yield investments could see even more risk as rates rise and the cost of borrowing continues to increase. "There is a big difference in risk between REITs and short-term bonds," said Williams, noting that, while short-term bonds may not have as high of a yield as REITs, they do provide stability in a portfolio, even when interest rates are quite low. "Sometimes you want some things in your portfolio that don't rise and fall as much," he said.