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Looking for an income boost? Here’s what you need to do
It could be years before interest rates return to normal. That's tough for anyone who needs an income from their investments. But it can be done, says John Stepek. Here’s how.
It is still possible to eke an income out of your investments
Will they? Won't they?
The US Federal Reserve started raising interest rates at the very end of last year. Then markets around the world collapsed. The Fed panicked. It pulled back. Markets recovered.
Now everyone's jolly again. The Fed is back to talking about raising rates, either next month, or July. Apparently the market is fine with that.
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Join more than 165,000 subscribers and keep yourself informed with latest financial news, insights and expert analysis to help you understand what really matters when it comes to your finances.
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So how can anyone who needs an income get by in this sort of environment?
We have a suggestion
History shows that interest rates could stay low for a long time
Markets are going through an optimistic phase. The Fed is hinting at raising interest rates and so far no one is freaking out. In fact, they think it's a good thing.
And maybe it will be a good thing. Rising interest rates are good news for the banking sector. And you don't tend to get a bull market going without a healthy rally in the banks. (My colleague Charlie Morris over at The Fleet Street Letter is putting together some stuff on this right now it's very exciting).
Yet given the glacial pace of rate rises, it's going to be hard work getting back to anywhere near normal. It's hard to imagine exactly what interest rates of 5% would do to markets right now, but it wouldn't be pretty.
Hedge fund tycoon Ray Dalio of Bridgewater Associates one of the most successful living investors reckons that even if there are further increases, this rate rising cycle will end at a far lower level than we've seen in the recent past, before rates have to come back down again.
He has the historical data to prove it. If you go back to the last time we had a generational financial crisis in the US (the Great Depression), then you'll find that it took a very long time indeed for rates to "normalise" after the slump.
According to data in Dalio's e-book, How the Economic Machine Works, US interest rates (as measured by Treasury bills) hit a low of 0% in 1932. It took more than 20 years before they were back above 2% (2.1%) that was August 1953. Rates then went back down to a low of 0.65% by the summer of 1954.
The next peak was just above 3.5% in October 1957. Rates didn't get within sniffing distance of 5% again until the end of 1959.
The 5% solution
Could we see that sort of thing again? My colleague, David C Stevenson, thinks so. If your postie has already arrived today, then you may have spotted his cover story in this week's issue of MoneyWeek magazine (and if you're really keen you might even have read it!).
But David opens his piece with quite an eye-opener of an anecdote. He was chairing a gathering of about 100-odd worthies and boffins (well, analysts and hedge fund people) in the City recently, and they were asked to vote on when we might next see interest rates above 2% for more than 12 months on the trot.
Their average answer? 2048.
That took me aback. And if I'm honest, I still don't see how they can be right. But then you look at Dalio's data and you think what if?
What would that mean? That sort of low rate environment is pretty hostile to anyone trying to build a healthy pot of savings for their retirement, because low rates mean low returns too. Anything risk-free will effectively deliver a return of 0% or below.
It also means that your pot will run out more quickly. In today's world, the traditional withdrawal rate of 4% (that is, the amount you take out of your pension pot each year after you start to draw on it) is likely to leave you penniless and dependent on the state before too long. Morningstar reckons a rate of more like 2.5% is right today. What kind of retirement would that mean for most of us?
This is all particularly nightmarish given that we all now have much more responsibility for building our own pension pots, as the government increasingly steps back (I see Adair Turner former head of the Financial Services Authority has been calling for the state pension age to be raised even more rapidly).
David thinks he has an answer to all this. And that's why we've added him to the Lifetime Wealth team.
You may already subscribe to Lifetime Wealth it's something we recommend for virtually all MoneyWeek readers we put it together especially for our audience. But for those who don't, I'll take a moment to explain the background.
Lifetime Wealth is a sister publication to MoneyWeek that I, Merryn Somerset Webb, and MoneyWeek managing editor Cris Sholto Heaton have put together to provide a way to build your wealth over the long run.
What with pensions freedoms and the cost of financial advice, we wanted to devise a simple, low-cost, low-hassle, DIY plan that would provide just about any MoneyWeek reader with a desire to save for the long term with a suitably diversified, relatively hands-off portfolio.
It follows our core principles: diversify, focus on beating inflation than some other artificial benchmark, and cut your investment costs to the bone. It's easy to follow, it's based on proven investment principles, and so far the reaction from readers has been very positive.
But given today's low rate environment, and the increased freedom to do what you want with your pension pot when you retire, we wanted to take things a step further.
David is putting together what he calls "the 5% solution". In short, it's his goal to build a portfolio where the focus is on generating a decent income around 5% a year from your wealth, rather than necessarily growing it over time.
That's the sort of income stream that could make achieving your hopes and dreams for your "third age" a great deal easier.
If you want to find out more, David's written all about it in this week's copy of MoneyWeek magazine. Sign up for a subcription now and get your first 12 copies for £12.
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