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JULY 28, 2003
The Surprise Threat to Nest Eggs Disinflation and subsequent falls in interest rates especially hurt retirees Don Lane thought he was set when he retired three years ago at 54 from a computer job in Wichita Falls, Tex. To tide him over until he could collect Social Security at age 62, he put his savings into safe, fixed-income investments. Most went into 20-year Fannie Mae and Freddie Mac bonds yielding over 7%, the rest into a money-market fund yielding 5%. Then came disinflation -- and a steep fall in interest rates. Fannie Mae and Freddie Mac called his bonds, and when he bought new ones, those were called, too. The coupons on his current bonds are just over 5% -- and subject to calls. Meanwhile, the money-fund yield is less than 1%. "It barely pays the monthly bill for water, trash, and sewer," Lane gripes. "I'm having a race between the cash I have in the bank and the time until I get Social Security." Retirement planning has always emphasized protecting nest eggs from the damaging effects of inflation. These days, retirees are reeling from a disinflationary wind that few could have expected a few years ago. Some economists even forecast outright deflation. Government data confirm that low rates hurt retirees and near-retirees more than they hurt younger people. According to the Federal Reserve's Survey of Consumer Finances, 30% of households headed by someone age 65 to 74 owned certificates of deposit in 2001, as did 37% of households headed by someone 75 or older. By contrast, only 15% of households headed by 45-to-54-year-olds held CDs. And people in or near retirement borrow less, so they don't enjoy the bright side of low rates. Among the 75-and-overs, only 29% of households carry any debt at all, compared with 85% of the 45-to-54 group. What to do? Most people in or near retirement can't afford to take a lot more risk in search of higher yields. The safest advice is to cut costs. If you still have a mortgage, refinance it at today's low rates. Beyond that, the right strategy depends on what you expect to happen next. Deflation, if it hits, would probably be accompanied by a recession. In that case, ultrasafe Treasury bonds would post excellent returns. Another good bet would be an annuity with a fixed monthly payout -- as long as the issuer is unlikely to default. Don't get fixated on deflation. With low inflation and weak economic growth, an array of bonds, including investment-grade corporates, should do well, as should blue-chip stocks in sectors such as health care that aren't vulnerable to imports. Build an inflation hedge into your plans. The U.S. Treasury's TIPS or I-Bonds are great choices, since their values increase with the cost of living. Inflation is no friend of retirees. But as Don Lane can tell you, it's not their only enemy.  By Peter Coy Get BusinessWeek directly on your desktop with our RSS feeds.  Add BusinessWeek news to your Web site with our headline feed. Click to buy an e-print or reprint of a BusinessWeek or BusinessWeek Online story or video. To subscribe online to BusinessWeek magazine, please click here. Learn more, go to the BusinessWeekOnline home page  | | |
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