With interest rates low, invest to stand test of time, inflation
What can income oriented investors do in this low interest rate environment?
It is my opinion that investors seeking income should consider investments that have the potential to combat the effects of time and inflation.
Consider that in order to generate $50,000 of passive income by purchasing a 30-year U.S. government bond earning 3 percent, you would need to invest about $1.67 million. This income would never change for 30 years.
That seems like a bad deal to me because your income never increases, but due to inflation your expenses will. And, if you are on a fixed income, look out if you live too long.
Many people in this area have a Boeing pension, so the actual cash savings don't need to be as high. But, the same problem applies once you lock in a defined benefit: inflation immediately starts to be your nemesis.
There are many risks that can have a huge impact on a retirement. I believe one of the primary risks today is longevity.
The challenge I face on a daily basis is looking for ways to create passive income streams for my retired clients. This has become increasingly difficult in a very low interest rate environment.
Put simply, we are living longer – much longer – than generations before us. When Social Security was adopted, the average retirement age was about 62 and the average life expectancy was about 68.
This meant that the time needed for a retirement income was less than 10 years, and it might be a little longer for a joint life expectancy when you included a spouse. Nowadays, we are generally planning for 30 years of retirement.
My grandfather lived to age 104, and my father to 90. My mother – who smoked, drank, never exercised and ate bologna and cheese her whole life – made it to 80. Modern medicine is a marvelous thing. Obviously, genetics play an important role.
That brings me to what I believe is the second biggest risk: inflation. For example, at 2 percent inflation, your $50,000 in 30 years will need to grow to over $90,000 just to stay even.
As a financial advisor, one of the income oriented strategies I often recommend is investing in common stocks that historically pay dividends. This approach has the potential to overcome time and inflation – the key word here being potential – since stock prices will fluctuate and dividends are not guaranteed. Bond investing, by nature, does not have the same growth potential, but involves less risk.
Let me give you an example. AT&T has been paying and increasing its dividend for more than 25 years. The current dividend is about 4.75 percent, and was recently increased by about 2 percent. (Source: Yahoo Finance) This could be suitable for a current retiree, depending on their risk tolerance, investment experience and diversification of other holdings.
Please, keep in mind that the stock price has fluctuated and AT&T dividends are not guaranteed. This is not a recommendation to buy or sell, but it is an example of what I am talking about.
Another example is Microsoft. Its dividend started out very small, but the increase in the dividend payments have accelerated. In 2003, Microsoft paid out its first quarterly dividend of 8 cents a share. Today that has increased to 39 cents a share, an almost 400 percent increase.
Keep in mind that I’m referring to past performance, which may not occur in the future.
For people in their 50s with 10 or more years of work before retirement, this strategy of looking for companies that pay small dividends with potential annual increases could be appropriate.
There are no perfect answers. We do know that longevity and inflation are very real risks that should be addressed. Be aware and plan for it.
And, remember: before you make a significant financial decision, get a second opinion.
Jeffrey Moormeier of JG Moormeier Financial is a Mukilteo-based financial advisor affiliated with KMS Financial Services, an SEC registered investment adviser. His column does not represent the opinions of KMS Financial Services, nor is it an official prediction or recommendation of any kind. The opinions expressed in this column are generalizations. For advise catered to your specific financial circumstances, contact Jeff directly at email@example.com or 425-931-8898.