Drop in Interest Rates Hits Retirees in the Pocketbook
Kenneth Jarosch fired his lawn service and canceled his magazine subscriptions. He and his wife are such avid users of grocery coupons that the store pays them to shop, he jokes.
But still, the 60-year-old retiree is worried about his financial future. And it’s because of the same plunge in interest rates that has many younger Americans cheering.
The decline in rates to 40-year lows, a drive engineered by the Federal Reserve, has made mortgages and car loans cheap for consumers.
On the other side of the equation are people such as Jarosch. Their income has been slashed over the last two years as yields have tumbled on bank savings certificates and other conservative accounts favored by retirees.
The average yield on money market mutual funds this week fell below 1% for the first time since the funds were created in the early 1970s. Two years ago the funds were paying 6%.
Unless savings rates head back up soon -- which many experts consider unlikely -- Jarosch said he will have to start tapping his principal to pay living expenses.
“We have cut expenses to the bone. Absolutely everything that’s not essential has had to go,” said Jarosch, who lives in St. Paul, Minn. “But we have nowhere to hide. Instead of living off cash flow, I will have to dig into savings.”
Older Americans have faced low interest rates before, but not since the late 1950s have yields on basic savings instruments been so low. For most of the 46 million Americans age 60 or older -- many of whom live on fixed incomes -- the paltry rates available on bank CDs, money funds and similar accounts are unprecedented.
Of course, savings and investment returns have been poor for more than just older people in recent years. The stock market’s decline since March 2000 has wiped out trillions of dollars of small investors’ wealth.
The difference is that younger people may have time to make up lost savings. For many retirees, the nest egg they have now must last as long as they live. And some say the deep decline in savings rates is threatening to systematically impoverish them.
“The reduction in interest income is affecting the way I have to spend and think, because it means I have to get into the principal that’s generating the income,” said Jim Daugherty, a retired aeronautical engineer in Memphis, Tenn. “That defeats itself. The more you reduce your savings, the more you reduce your income. It becomes a vicious cycle of your expenses eating up your savings.”
At age 82, Daugherty said he’s not too worried about outliving his money as long as he continues to live frugally. “But if I were age 65, I’d be mightily concerned.”
Younger retirees, such as Bob Ring of Laguna Woods, say they see few options but to cut back on spending. Ring, 69, says he used to go to sporting events several times a year and he and his wife normally plan a big vacation once every three years. This year, he hasn’t gone to any sporting events and the trip to Australia that he’s been pining for since 2000 has been indefinitely tabled.
“When I know that income and outgo are running awfully close or negative, the first thing that gets cut are the luxuries,” Ring said. “Give us another year of this, and the cuts are going to start getting noticeable.”
The financial reality for many seniors is at odds with the Federal Reserve’s basic goal in pulling shorter-term interest rates down to current levels: The central bank is trying to help the economy, not hurt it.
The Fed, under Chairman Alan Greenspan, began slashing the cost of money early in 2001 as the economy slumped into the first recession since 1990.
The Fed controls short-term interest rates by pumping money into the banking system or by removing it. By lowering borrowing costs, the Fed has sought to keep the recession from snowballing.
Even as the economy has recovered this year the central bank has kept rates down, and it cut them again Nov. 6. With the stock market suffering its worst losses since the 1930s, the Fed has feared that the decline could tip the economy back into recession, experts say.
But “had there been no interest rate cuts, the economy would be better off,” groused octogenarian Frank Brier of Philadelphia. “Millions and millions of people with bank accounts, CDs, annuities, bonds and other interest-bearing vehicles would have more money to spend.”
Indeed, the sum in bank CDs and basic savings accounts totals $3.6 trillion, according to Fed data. Small investors have $900 billion in money market mutual funds. The total of those accounts far exceeds the $2.7 trillion in stock mutual funds.
“When the Fed is lowering rates, it is hurting the people who lend and helping the people who borrow,” said Alan Blinder, a Princeton University professor and former Fed vice chairman. “The Fed knows that. But basically, that’s the only weapon they’ve got” to fight a recession, he said.
The central bank also understands another financial reality: The U.S. economy is far more dependent on the spending of younger and middle-aged people than older people.
The average household headed by 65-to-74-year-olds spends $30,800 a year, according to a government survey in 2000. But that pales compared with the $45,150 average of households headed by people 35 to 44, said Susan Sterne, head of Economic Analysis Associates in Greenwich, Conn.
People 65 and older account for 14% of spending in the economy, Sterne said. “They are a very small share of total consumer spending,” she said.
Some economists also point out that although short-term interest rates are extremely low in nominal terms, the situation for many savers was worse in the 1970s because inflation was far higher -- eating up savers’ purchasing power.
But many seniors say their personal inflation rates today don’t jibe with the government’s statistics that say the rate of inflation is about 2%. Rising living costs compound the pain of the drop in interest earned on savings instruments, they say.
“Our biggest problem has been the rise in medical insurance premiums,” said Lonell Spencer of Arcadia, a retired machinist. “Three years ago, we paid $107 a month. Last year, our premium went to $191. This year it went to $602 and next year they said they won’t cover us at all.”
Jarosch said his medical insurance premiums have jumped nearly 53% this year, his property taxes are up 16% and his homeowner’s insurance premiums have risen 47%.
Meanwhile, his money market account interest income is down 85% over the last two years, and his pension and Social Security income has risen by less than 2% over the last year.
Even though the economy is showing signs of picking up steam, many economists believe the Fed will be reluctant to raise short-term interest rates until well into 2003, for fear of stalling the recovery. That was the Fed’s pattern in 1992 and 1993: It kept rates low for most of that period, waiting for the economy to rebound decisively.
“I think these low rates are going to persist for a while,” Blinder said.
That prospect offers little hope to savers who had planned on the yields of a few years ago continuing indefinitely.
For those who seek to boost their income from savings or investments, the choices are difficult. The only way to get a better return is to take more risk -- for example, by investing in the stock market or in corporate bonds.
But for someone like Jarosch, “the problem is that the risk level that he would have to reach to meet his income requirements would probably not be prudent given his age,” said Christopher Orndorff, portfolio manager at Payden & Rygel, a Los Angeles investment firm.
Some financial advisors say it’s almost imperative that retirees with a long time horizon have at least a modest portion of their assets in stocks, which over periods of decades still are expected to produce the highest returns of all financial assets.
Retirees “naturally are very gun-shy of having any risk in their portfolios,” said Steve Norwitz, an officer at mutual fund giant T. Rowe Price Associates in Baltimore. “But the risk of running out of money if you have a long time horizon can be greater than the risk of having another down year in the market.”
Still, Norwitz acknowledged that it’s tough to sell that message to many Americans, including retirees, given the stock market’s losses of the last 2 1/2 years.
“You tell this to somebody who has lost 40% of their account value over the past two years, and they say, ‘Yeah, right. Let’s stack your graph against my recent account statement and see what’s more convincing.’ ”
