Because of its potential negative impact on retirement savings, retirement savers should seriously consider the recent Trump interest rates cut the President put before the Federal Reserve. Here’s what you need to know about this appeal to help you plan accordingly.
In this article:
- How Does a Lower Interest Rate Impact the Trump Economy?
- Impact of Lower Interest Rate in the U.S. Bond Market
- How the Trump Interest Rates Cut Plan Can Affect Retirement Savings
- How to Deal with the Planned Rates Cut
How the Trump Interest Rates Planned Cut Will Impact Retirement Savings
How Does a Lower Interest Rate Impact the Trump Economy?
Higher interest rates can slow down economic growth in several ways:
- They make borrowing money for financing business operations more expensive.
- Higher interest rates also make expanding businesses more expensive.
- Rising interest rates are also unfavorable for Wall Street, particularly the stock market. There’s an inverse relationship between the Fed rate and the stock market — when one goes up, the other goes down.
- Higher interest rates also contribute to slower economic growth by pushing mortgage rates higher. As such, fewer people can borrow money to buy houses, which can have a trickle-down effect on the general economy.
And as the general economy slows down, the unemployment rate can go up as more businesses have to let employees go. It can become a downward spiral if it persists.
On the other hand, lower interest rates can result in faster economic growth because:
- They offer lower borrowing costs for businesses.
- They also make it easier for individuals to borrow money to buy their own homes because mortgage rates are lower.
With the ability to finance business expansions and buy homes, the general economy can grow faster. And when the economy grows faster, the unemployment rate goes down, too, as more job opportunities arise.
When the economic outlook is bright, Wall Street is happy. When the economy’s bullish, the stock market is generally bullish, too.
Impact of Lower Interest Rate in the U.S. Bond Market
Despite the potential positive impact of the Trump interest rates plan on employment, real estate, and stock markets, and the general economy, lower interest rates are bad for fixed-income security investments. Why?
Prices of fixed income securities, such as treasury and corporate bonds, and the Fed rate have an inverse relationship. When the Fed rate goes down, bond prices go up.
The reason for this is bond yields track the movement of the Fed rate. Bond yields and bond prices have an inverse relationship, too—lower bond yields mean higher prices for debt securities.
How the Trump Interest Rates Cut Plan Can Affect Retirement Savings
If the Fed Chairman heeds the President’s call to slash the federal rate to zero or below, retirees and savers who are approaching retirement may suffer.
Retirement savers who are close to retirement need to realign their retirement portfolios. To be specific, they need to shift most of their investments to conservative assets, such as fixed-income securities.
- Savers who are still early in their careers have enough time to recover from potentially massive losses in stock investments.
- On the other hand, savers who are close to retirement will need their money in a few years’ time. They can’t afford to take high risks with market-driven investments such as equities.
But if bond prices are high, buying them is a high-risk bond investment, especially close to retirement. The chances are high that retirees might suffer losses from selling such bonds later when bond yields go back to normal and prices go down.
On the other hand, coupon payments on bonds stay the same regardless of bond yields and prices.
What are Coupon Payments? These refer to the periodic interest payments on bonds that investors receive from bond issuers.
- A bond with a $10,000 face value and a 2% annual coupon rate will give investors $200 in total coupon payments every year.
- Whether they buy this bond for $11,000 or $9,000 in the secondary bond market, investors will get a total of $200 in coupon payments annually.
If the Fed Chairman indulges President Trump and slashes interest rates drastically, it results in lower bond yields. In turn, it leads to higher bond prices.
Using our earlier example, the cost (or investment) of the opportunity to earn $200 in every year will be higher, too. Ultimately, this means less retirement income.
How to Deal with the Planned Rates Cut
Fortunately, individuals who are either retired or close to retirement can mitigate the effects of a possible federal rate cut.
Retirees and savers can put money in certificates of deposits (CDs), bonds, and/or U.S. treasuries maturing across different years. The idea is to invest different amounts of money such that every year, they mature to a specific annual income amount.
This strategy has three benefits:
- It protects against deflation because they earn interest.
- The value of such investments will go up if rates drop further.
- They lock in on a specific amount of money every year, even if rates rebound.
For example, John needs $50,000 every year throughout his retirement. He reallocates his retirement portfolio across different CDs and bonds/treasuries that mature to $50,000 in different years.
How much will John potentially earn?
- Every year, John will receive at least $50,000, which is the maturity value of the fixed-income securities he invested in. This amount is guaranteed, regardless of where bond yields are in their maturity.
- On top of the $50,000 maturity value, John will also get coupon or interest payments. Both the maturing and still outstanding CDs and/or bond/Treasuries will provide such payments to him regardless of current bond prices.
The Trump interest rates cut plan can hurt bond prices and returns on investments if implemented. As such, it may also have negative implications for retirees and those who are approaching retirement.
A proper retirement investment reallocation strategy, such as the one discussed above, can mitigate the potential impact of this plan. By reallocating fixed income security investments with specific maturity values for every year of retirement, reduced federal rates are less likely to affect retirement savings.
Do you think that the Trump interest rates cut plan will have a significant impact on your retirement savings if implemented? If yes, how? Let us know in the comments section below.
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