Here's How the 30-Year Treasury Hitting 5.12% Could Hurt Retirement Portfolios
On the surface, a 30-year U.S. Treasury yield above 5% might seem like a good thing for savers. During the pandemic era, 30-year yields fell below 1%, meaning current investors would be earning more than five times as much interest.
But a high 30-year Treasury rate means a lot more than higher interest payments. It helps set the tone for mortgage rates, credit card interest rates, corporate borrowing costs and even stock valuations. High interest rates make life more expensive for both companies and consumers. The negative effects can ripple throughout the entire economy, potentially creating stagflation.
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During stagflationary periods, inflation remains high while economic growth slows. This is problematic for consumers and investors alike. Stagflation often tips the economy into a recession, which can drag down investment returns while prices continue to rise.
Here are some of the ripple effects of a high 30-year Treasury yield.
How Higher Long-Term Rates Affect Both Stocks and Bonds
Bonds can provide some measure of protection from stock market declines. That’s why investors tend to buy more conservative investments when the stock market becomes more volatile. But this doesn’t mean that bonds are “safe.”
When interest rates rise, bond prices fall. Higher rates can provide a good return on new purchases, but existing bondholders lose value when rates rise.
A rising 30-year yield can also cause trouble for the stock market.
When it costs more money for consumers and companies to borrow, it can hurt stock market valuations. With less money in their pockets, consumers buy fewer goods and services. When companies have higher expenses, they post smaller profits. Both factors hurt stock prices.
A high-yielding 30-year Treasury also provides competition for investment dollars. When an investor can get a 5% rate guaranteed by the government, some investors see the stock market as too risky. This takes money out of the stock market, resulting in lower prices.
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How Stagflation Can Shrink a Retirement Portfolio
Stagflation is a double-edged sword when it comes to retirement portfolios. The inflation part of the equation raises prices for everything from food and insurance to utilities, medical care and more. When it pushes interest rates higher, that also hurts bond prices. Simultaneously, slower growth can drag down stock prices. The net of it all is that retirees living on a fixed income could suffer from the combination of higher prices and lower asset valuations.
The problem is exacerbated for retirees because reduced values can become permanent damage.
Imagine a retiree who needs $50,000 per year for living expenses. In an inflationary environment, those costs might rise to $53,000 per year. Meanwhile, as described by Charles Schwab, "sequence of returns risk" describes how withdrawals made while stock and bond prices are low lock in those losses permanently. If asset prices recover, the money withdrawn from the account will no longer be around to bounce back.
Defensive Rebalancing Rules for Older Investors
Older investors on the cusp of retirement should consider playing a bit of defense. Here are some proactive steps you can take to protect against higher interest rates.
1. Examine Your Timeline
If you’re within five years of retirement, consider dialing down your stock market exposure. If your portfolio drops 30% right before you retire, you may have to work longer or save more money to ensure you have enough to meet your retirement needs. That’s a position most pre-retirees want to avoid.
2. Build Liquid Reserves
Second, keep a significant amount of money in safe, short-term assets like high-yield savings accounts. This money can protect you from being forced to sell volatile assets during a market downturn.
3. Seek Shelter in Stability
Review your bond portfolio allocation. Some investors get lured by high yields and invest primarily in long-term bonds. But if you try to maximize yield like this, you’re vulnerable to a potentially significant drop in your account value if rates continue to rise.
4. Rebalance Periodically
Create an appropriate asset allocation and rebalance when necessary. For example, if your target is 50% stocks and 50% defensive assets like bonds, rebalance when either side drifts by five percentage points. That forces you to sell assets that have gone up and add to beaten-down ones without trying to time the market.
5. Stress-Test Withdrawals
If a 4% withdrawal rate only works when markets cooperate, you likely have to set that rate lower for the long term. Vanguard research on bear markets and retirement highlights how sequence risk can make high withdrawal rates risky.
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This article was provided by MoneyLion.com for informational purposes only and should not be construed as financial, legal or tax advice.
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