A penny saved is a penny earned. First written during the 17th Century, this adage is still as true today as it was then. In fact, in our current investing environment, it may be a whole lot easier to save a penny than it is to earn one through investing. The prevalence of low-interest rates has made saving much more valuable for anyone who wants to build enough wealth to retire comfortably.
What History Tells Us1
Historically, falling interest rates were great for bond investors, whereas rising rates lowered bond returns. Economists have found that since 1913, U.S. stocks have performed well during periods of falling interest rates, with an annual average return of 9.3%, but have gained a meager 2.3% when interest rates increase.
Bonds tend to follow the same pattern. When interest rates fall, bonds have returned an annual average of 3.6%, which drops down to only 0.3% when rates are increasing. The researchers calculated in the effects of inflation to get to these numbers. This makes low-interest rate environments a challenge for both stock and bond investors.
Our Current Situation2
For the first time in our nation’s 240-year history, the yield on the 10-year Treasury bond fell below 1.4% on July 5. The low rates as we are experiencing right now are not unprecedented. In fact, in the 1940s and 1970s, they were common worldwide.
The big difference between now and then is the relationship between low rates and inflation. Often, low bond yields are accompanied by high and unexpected inflation, as was the case in the 1970s. However, our current low-interest rate environment was purposefully created by central-bank policies in an attempt to stimulate growth in the economy.
Such low rates as we are experiencing now have nowhere to go but up. As we saw with the historical numbers, rising rates mean dismal returns for both stocks and bonds.With future interest rate increases inevitable, investors will not be able to depend on the markets to build their wealth as they have in the past.
But on the flip side, low interest rates are taking a toll on investments, like certificates of deposits, that many retirees and others on fixed incomes rely on. Take a look at this example of what is happening with a 6-month CD. In 2006, the income generated on a CD was approximately double what was needed to beat inflation. Fast-forward to 2015, where a $100,000 investment only made a measly $370, far below what is required to handle rising inflation.
What This Means For You
Investing is said to be a partnership between you and the markets. Sometimes, as in the 1980s and 1990s when both stocks and bonds were soaring, the markets did most of the work. In our current investing environment, the markets have decided to take a break, and you have to be the one to take over the bulk of the work.
What does that mean? It means that you need to rely on saving, rather than returns, to grow your wealth. In this environment of substantially lower returns, you will need to increase your savings rate if you want to build a nest egg that will sustain your lifestyle into retirement.
How We Can Help
At Emery Howard, we understand the complexities of the current investing environment and your need for a sustainable income in retirement. We can help you calculate how much you need to be saving right now in order to maintain your lifestyle after you stop working. Together, we can develop a plan that will enable you to live the life that you want during your golden years.