Monday, April 11, 2011

The Danger of Safety

It's not news that interest rates are still at historically low levels.  Five year CD's are now paying less than 2.5%, and savings accounts effectively have no interest rate.  This is good news for borrowers, and it all stems from the efforts of the Federal Reserve to rescue the economy from the financial crisis.  It is not, however, good news for people hoping to use interest income to supplement their retirement income.  A great explanation of this appeared in last week's Wall Street Journal,  Fed's Low Interest Rates Crack Retirees' Nest Eggs.  Here's a quote and a chart:

"The longer the central bank keeps interest rates low to stimulate the economy, the more money it pulls out of the pockets of millions of savers. Among the most vulnerable are retirees, who have few options to restore lost income on investments built up over entire lifetimes...average annual investment income for the 24.6 million American households headed by people 65 and older amounted to $2,564. That figure is down 34% from 2007, and is the lowest since 2003."

This all reinforces the idea that there really is no such thing as a totally "safe" place to put all of your money.  Interest and inflation rates are not stable, and being on the wrong side of the investment track when they switch places can have serious repercussions on one's financial life.  Life is risky, and that probably won't change anytime soon.  We believe the best long term strategy is to have money in different types of assets - Cash, bonds, stocks, real estate, etc. This spreads your overall risk making it less likely that one event will significantly influence your general standard of living.

The reason that these retirees' nest eggs are cracking, is because all of their eggs were in one basket.  Never a good idea, since sometimes the basket gets dropped and all the eggs crack.