As you approach the milestone of retirement, the financial landscape can seem like a maze of shifting goals and economic jargon. Among the critical elements influencing your retirement planning, interest rates stand out as a meaningful factor. Understanding how interest rates impact your savings, investments, and overall financial health is essential for making informed decisions.
For those planning to retire within the next decade, interest rate fluctuations can have a big impact on the wealth you can accumulate in the last leg of the race to retirement. In this blog, we’ll delve into how interest rates affect your financial future and provide strategic insights applicable to pre-retirees.
Interest Rates and Investment Returns
Interest rates significantly influence the returns on various investments, such as lump sum pension payouts, bonds and savings accounts. Generally, when interest rates rise, savers are happy to see earnings in the bank savings accounts. While, bond mutual fund or exchange traded funds (EFTS) may see their account values decline. This is also true for lump sum payouts from pension plans.
Lump Sum Pension payouts:
For near retirees that are thinking of taking a lump sum from their pension plan instead of a monthly payment they could be surprised by the current payout amount versus what they may have calculated a few years ago. Interest rates and pension lump sum values have an inverse relationship. As interest rates increase the lump sum amount will decrease. This is due to a higher interest rate being utilized to determine the present value of their income payments. This could have a dramatic impact on the amount you are planning to retire with.
Bond mutual funds and ETFs:
Interest rates and bonds have an inverse relationship. When interest rates increase the bond price will decline in order for the bond to be valued at the new interest rate. For many in 2022 they saw their bond portfolios fall in value due to interest rates increasing significantly. Think about it this way, if you have a bond that pays 2% and the new interest rates are 4% no one will be interested in buying your bond. Therefore, the price has to fall to generate any buyers. This does not mean that your portfolio will always be at a loss. The fund or EFT managers can hold those bonds until maturity and continue to buy new bonds with incoming cash from interest and bond maturities. It will just take some time for the portfolio to catch up with the new interest rates. We usually recommend that retirees evaluate their cash needs for the next three to five years and hold that cash in securities that will protect their principle, such as money market funds, CDs, or short term bonds that will mature at a specific time versus a fund or EFT.
Savings accounts:
For savers, increases in interest rates are a welcome change. When interest rates increase this allows them to earn more income on their savings. For many years since the Financial Crisis of 2008 interest rates were at very low levels. It was very hard for people that want to hold cash in savings accounts or even CDs and bonds to earn income. Many moved to riskier investments or longer term maturity CDs or bonds in an attempt to earn higher income.
Interest Rates and Debt
We’ve primarily touched on the earnings side of interest rates. Of course, we all know interest can wreak havoc on a budget when it comes to credit cards, auto loans, and mortgages. When you have adjustable rate debts you may be surprised at the impact increasing interest rates can have on your ability to pay the debt down. For example, some may use a home equity line of credit to do some home modifications a few years ago. When they started the loan the interest rate was probably much lower than it is today. With the increasing interest rates more of their monthly payment is going towards interest than principal now. This may impact their ability to pay off that loan in the period of time they were hoping to.
Strategic Financial Planning in a Changing Interest Rate Environment
While interest rates may be making the headlines, it’s important to remember that fluctuation is simply a part of the economy. A fee-only financial advisor can play a crucial role in helping retirees navigate these fluctuations by offering advice. Interest rates are just one piece of the puzzle, but understanding how interest rates affect your retirement plan is essential for ensuring financial stability in your golden years. By recognizing the influence of interest rates on investments, savings, and debt paydown, you can make more informed decisions. Reach out to learn more about how meeting with a financial advisor can further refine your approach.
About Foundation Wealth Management
Foundation Wealth Management is a CPA-led organization, that provides financial planning services and tax planning support; services and outcomes vary based on each client’s circumstances. Our team includes qualified professionals, such as CPAs and CFP®s, who are integral to our service offerings. Our team includes 3 Certified Financial Planners: Burt Hutchinson, CPA, CFP®, Paul LaViola, CFP®, and Stephen McDade, CFP®.
As Fee-Only planners, we are compensated directly by clients rather than through commissions from brokerage or insurance products, which we believe helps align our services with client goals.
Disclosure Statement:
This presentation is not an offer or a solicitation to buy or sell securities. The information contained in this presentation has been compiled from third-party sources and is believed to be reliable; however, its accuracy is not guaranteed and should not be relied upon in any way whatsoever. This presentation may not be construed as investment, tax, or legal advice and does not give investment recommendations. Any opinion included in this report constitutes our judgment as of the date of this report and is subject to change without notice. All investments are subject to risk, including the possible loss of principal.
Additional information, including management fees and expenses, is provided on our Form ADV Part 2 available upon request or at the SEC’s Investment Adviser Public Disclosure website, Past performance is not a guarantee of future results.
