How Interest Rates Dictate Planning Decisions
As investors approaching or in retirement you all need to understand a few fundamentals that will help you make the best decisions in regards to asset allocation. With respect to this I’d like to talk about interest rates as an indicator that give you some idea of how to plan and what to expect from market performance.
The first is to take a look at the US Treasury yield curve. This shows the difference between short and long maturity treasury securities. Obviously the shorter term treasuries will have lower yields and the longer term will have higher yields. For investors with a short time horizon, the lower yields are acceptable because money is liquid at an earlier date. Retirees with a long time horizon should look at the longer terms for stable planning over extended periods of time.
This explains what is considered to be a normal yield curve, with short term maturities paying low yields and the curve steadily rising and maturities increase. This would happen when the long-term economic outlook is positive. Short and long term investors get exactly what they need. Retirees in this case would find that the products designed for guaranteed income are priced appropriately and offer a good deal.
Right now, the yield curve is basically flat and that is an indicator of economic uncertainty. Take a look at the US Treasury yield chart using this link. The 1-year is 2.42% but the 30-year is only 3.03%!
So if you loan the federal government your money you do almost as well with a one year commitment as you would by locking up your money for 30 years. This directly correlates with the retirement products the majority of financial advisors are selling. Long-term products are based on the long-term market yields and it doesn’t make sense for planning purposes to lock money up for extended periods of time unless you are paid a reasonable yield to do so. That option doesn’t exist in the products available today.
The best deals are in the short-term opportunities. You’ll earn nearly as much interest but have your funds liquid at an earlier date and available for re-positioning as markets change.
What about a third type of yield curve? Let’s assume that short-term rates are higher than long-term rates. This would be called an inverted yield curve and it signifies a poor extended outlook for the economy.
This doesn’t happen often but when it does it leads to serious market volatility that will wreck a portfolio. Recovery could take several years and require a steel nerve that would make Josey Wales back down.
One of the more well-known indicators of this happening is seen in the difference between the two and ten year treasury.
As of the market close on August 10th, 2018 the 2-year is at 2.61% and the 10-year is at 2.87%. Take a look at this article that explains what happens when those yields switch and the 10-year pays less than the 2-year. In all points through history when the yield curve inverts over this time period it precedes a wicked market correction. It’s reason to be cautious when making allocation decisions, and with equities markets recently approaching or reclaiming historic highs it’s not a bad time to protect some assets.
The above article about treasury spreads is from earlier this year and I have shared it with several of you. The fundamentals and our current economic situation have not changed so I felt a little urgency to get this out to as many people as possible. Several analysts are calling for an inverted yield curve within the next year. I don’t like to make predictions but I do like to provide justification for the strategies I promote at AST. Whether the yield curve inverts or not makes no difference to me. I just want you to be ready if it does.
Keep your commitments short and flexible. Set enough aside so you can weather a market downturn without sacrificing retirement lifestyle. Be ready to make changes as time passes so you can increase wealth through retirement.
Planning is simple when you do it right. If you have any questions feel free to call or email any time.
All my best,
Bryan J. Anderson