Low Yields Hurting Retired Investors

The lowest interest rates in decades may be good news for borrowers, but they’re causing many older Americans to tighten their belts--and worry about the future.

Retiree Leonard Howell, 83, has watched the yields on his certificates of deposit slide from 6% last year to less than 3% today. Accustomed to living on CD interest and Social Security checks, Howell and his disabled wife have been forced to dip into savings to pay the bills at the Arlington, Texas, retirement center where they live. Now Howell is confronting his worst fear: running out of money.

“We don’t eat out. We don’t go out. We stay in close and try to survive,” Howell said. “I’ve been able to stave off disaster so far, but it looks bad.”

Savers who just last year saw yields reach five-year highs now are grappling with interest rates that have fallen to generational lows. The Federal Reserve’s eight rate cuts so far this year, a slowing economy, a tumbling stock market, investors’ flight to the relative safety of fixed-income investments and the Sept. 11 terrorist attacks all have contributed to the plunge.

Yields on taxable money market funds last week fell to their lowest levels in the funds’ 30-year history, with an average seven-day yield of just 2.55%, said Peter Crane, managing editor of IMoneyNet.com, which follows money market trends. A year ago, money funds averaged 6%.

Bankrate.com, which monitors CD yields, said returns on bank deposits are the lowest since the company began tracking rates in 1984.

Yields have dropped so low that many savers are actually losing money after inflation and taxes, financial planners said. Yet safety-conscious investors have few alternatives, and many say they don’t have the stomach for the risk needed to seek higher returns in stocks and other investments.

“Most people our age distrust the stock market, some with good reason,” said retired Visalia, Calif., postmaster Frank E. Marshall, 80, who remembers the 1929 crash. “I don’t want to take a risk at my age, because I don’t have the time to make [the money] back.”

Stocks haven’t proved a good alternative lately, in any case. The benchmark Standard & Poor’s 500 is down 21% so far this year.

Though lower interest rates are painful for any saver, they are particularly problematic for millions of senior citizens who count on their savings to supplement Social Security and pension checks.

Nearly two-thirds of people 65 and older received interest income in 1995, the latest year for which Census Bureau figures are available. Half of those received more than $793 in interest that year, and the average interest income was $3,144.

Those savers reaped the benefits as the economy boomed in the late 1990s. Low inflation and increased demand for money helped drive up real yields on interest-paying accounts and securities to their highest levels in years, economists said.

With inflation averaging 2.5% a year from 1995 through 2000 and one-year Treasury bills yielding an average 5.5%, real returns were about 3%--significantly above the 2% historical average for real returns over the last 30 years, said Michael Swanson, senior economist for Wells Fargo Bank.

Some CD owners did even better. Last year, as loan demand was peaking, several banks offered one-year CD rates of more than 7%. Last week the highest one-year rate listed on Bankrate.com’s Web site was 4.25%, offered by First Bank Inc. of Louisville, Ky.

Increasing Yield Involves Added Risk

Retiree Donald Cox of Burbank said lower CD rates already have trimmed $150 a month from his income, leading to fewer dinners out and concerns about holiday spending.

“With Christmas coming, we’re going to have to take a look at the gifts we give our 10 grandchildren,” said Cox, 71. “[Fed Chairman Alan] Greenspan has been lowering interest rates to help the economy, but it’s sure playing havoc with the senior citizens.”

Rates had been sliding for months as the economy slowed, but took a particularly sharp dive in the aftermath of the terrorist attacks. To keep the banking system flush with cash, the Fed cut its key target rate for short-term interest rates to 3% from 3.5%. But the Fed also went further, injecting money into the banking system and pushing short-term rates as low as 0.5% last week.

The Fed’s move to prop up the economy reduced yields on short-term securities issued by companies and government entities--the kind of investments money market fund managers typically buy. Meanwhile, investors fled a deteriorating stock market and rushed into money markets and bonds, further driving down yields.

CD rates also have fallen as banks make fewer loans in an uncertain economy, said Bankrate.com analyst Greg McBride. A reduced pace of lending means banks have less need for cash and are less likely to offer attractive rates for deposits.

Savers can’t count on relief any time soon. Money market rates may rise a bit in coming weeks as the Fed cuts back on its emergency funding. But most analysts expect another rate cut as the central bank tries to stimulate an economy headed for recession.

There are a few ways to squeeze out more yield from savings, but all involve taking more risk. For example, savers can find better returns by locking up their money longer. Five-year CD yields now average 4.23%, and savers who search the Bankrate.com Web site can find some banks offering more than 5%.

But savers who lock in longer-term yields now run the risk of missing out on better deals if rates rise in the next few years. The historical average for a five-year CD is close to 5.8%, so someone opening an account today definitely would be locking in a lower-than-average rate, McBride said.

Savers also could run into trouble if they need to tap their principal before their CDs mature. Most banks charge significant early-withdrawal penalties--the equivalent of three months’ to a year’s worth of interest payments--if a CD is cashed in before maturity.

That’s why many planners recommend “laddering” portfolios--in other words, buying CDs or Treasury securities of differing maturities.

A saver with $10,000 to invest, for example, could put $2,000 each into certificates with one-, two-, three-, four- and five-year maturities. One year later, the first CD matures, allowing the saver either to use the cash if necessary or to purchase a five-year CD. The next year, the two-year CD will mature, and once again the saver either has access to the cash or can buy a five-year CD. Eventually, all the money could be held in five-year CDs, with one maturing each year.

Because longer-term CDs and Treasury securities typically have higher rates, this approach allows investors to earn better yields while having access to a portion of their money each year in case of an emergency.

Laddering also limits investors’ risk if rates fall, because most of their portfolio will have locked-in higher rates. If rates rise, at least a portion of their money would be available each year to buy CDs with higher yields.

Many financial advisors also are recommending so-called ultra-short-term bond mutual funds as an alternative to money market funds.

Ultra-short-term bond funds, which are offered by most major mutual fund companies, invest in corporate and government bonds with average maturities of less than one year. Although the value of the funds can fluctuate somewhat--the funds’ share prices are likely to fall if market interest rates rise--their short-term nature means they act much like money funds, but with slightly higher yields, said Margie Mullen, a Los Angeles financial planner.

Mullen advises investors to look for ultra-short-term bond funds with low expenses, because high annual fees can offset a fund’s higher yields.

Most other income-generating investments--longer-term government or corporate bonds or bond mutual funds, dividend-paying stocks and real estate investment trusts, for example--involve greater risk that investors could lose some of their principal.

Treasury securities, of course, are guaranteed to repay their full face value at maturity. But if an investor must sell the security before maturity, the market price may be lower than the face value if interest rates on new securities are higher.

Similarly, bond mutual funds can offer attractive yields, but an investor’s principal isn’t guaranteed in bond funds.

Seniors Should Beware of Some Investments

Sometimes risks are worth taking to get better returns. Financial planners typically recommend that retirees have at least some exposure to stocks for their growth potential, for example. But planners usually suggest cutting back on stocks and shifting to bonds and money market investments or CDs as investors age.

And the sooner investors may need the money, the fewer risks they should take with it. High-risk investments of any type are unsuitable for older investors who depend on their savings for daily living expenses, planners say.

In times of low yields on CDs and other safe accounts, a desire for higher-paying investments can drive savers to take too many chances. Some advocates for the elderly worry that the current environment will make it more likely that seniors will be taken in by high-risk investments and outright scams as they search for higher yields.

When rates fall, seniors chasing better returns sometimes are sold corporate junk bonds, variable annuities or callable CDs--certificates that can have maturities of 20 or 30 years, said Ed Long, executive director of HELP, a Torrance-based nonprofit information service for seniors. Though suitable for some investors, these investments aren’t a good fit for seniors who need security and immediate access to their funds, Long said.

Others have purchased phony promissory notes, “prime” bank notes or investments in nonexistent ATM networks, regulators say.

“These folks are definitely targeted” by scam artists and unethical investment salespeople, Long said. “I’m seeing people awful worried about what they’re going to do with their investments. . . . There’s additional pressure when you depend on your savings to live.”

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A Sampling of Yields

Here are current rates on certificates of deposit. Treasury securities and money market funds and how they compare with rates a year ago. CD yields are national averages.

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Yield Last Week 1 Year Ago 5-year CD 4.25% 6.03% 5-year Treasury Note 3.80 5.84 1-year CD 2.94 5.65 1-year Treasury bill 2.60 6.09 Taxable money market funds (average) 2.55 6.00 Tax-free money market funds (average) 1.74 3.53

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Note: Money market rates reflect average simple seven-day yields as of Sept. 25.

Source: MoneyNet.com