Retirees, savers suffering in low-rate environment

It's not often one is seemingly penalized for committing to saving money but in our present low interest rate environment, big returns on savings and investments are impossible to come by. If you're on the cusp of retiring or have already retired it's a potentially dicey situation.

The Canadian inflation rate fell to 1.2 per cent in May, and according to Statistics Canada, it's now at its lowest level since June 2010. That in-turn is taking pressure off of the Bank of Canada (BoC) to raise interest rates in the near future. Moreover, with the U.S. Federal Reserve committing to keeping American interest rates low through to 2014, the BoC is expected to follow suit.

Savers forced to up the risk?

Drew Abbott, vice-president, investment advisor, TD Waterhouse Private Investment Advice in Toronto, says the present circumstance facing investors these past four years is changing the nature of financial advice in that risk, to a degree, must be increasingly embraced in order to realize true returns.

"The biggest thing is people's expectations have to be lowered … the client's expectations of double-digit returns is, in our case, long gone unless you take a great deal of risk," he says. "The challenge is how to get more yield with the least amount of risk.

"There's no magic wand here. Retirees, pre-retirees, or people just needing income from their portfolio have to step up their risk spectrum in some respect. Not only their dollar amount but their ability to withstand risk and understand it and to know what their timeframe is."

In search of higher yields for clients, TD is deploying a "barbell strategy" whereby advisors recommend investing in equity markets through preferred shares, large-cap Canadian equities paying dividends, and the high-yield bond space.

"On the other side of that barbell is to have a little more cash than normal just for a buffer on the volatility side or if there's a need for a large amount of cash in a short period of time," he explains. "It really becomes how comfortable one is with risk. That's a really personal decision."

Interest rates will eventually rise

Rod Tyler, a certified financial planner with Regina-based Tyler & Associates and a member of Advocis, the Financial Advisors Association of Canada, says he expects the BoC's actions to mirror those of the Fed for the foreseeable future.

"Rates pretty much are global now, so they're likely to stay lower for some time. Eventually they will go up," he says. "In the sense that we've had a 30-year down escalator for interest rates, the traditional mechanism for saving using long bonds has simply put people in a position where there isn't any income of consequence there."

Martin Lefebvre, a retail investment strategist at National Bank of Canada in Montreal, agrees retirees and savers are caught between a rock and a hard place of late. But in order to maximize one's investments, he too says one has to consider taking on a greater amount of risk.

"It's a dire situation investors are in right now. Yields are at historical lows so one thing pension funds have to do is to go even further down the yield curve so they're taking risk and they can guarantee some form of income for their investors," he says.

"The reverse of that though is they're adding risk by doing that. There's also a risk though of mismanaging their portfolio. One thing we know, right now probably half of the stocks on the S&P 500 have a yield that is higher than what you can get on the bond market. I think there'll be some inflows into the stock market going forward."

Annuities also taking a hit from low interest rates

Annuities, whether variable or fixed rate, are also being negatively impacted Lefebvre notes.

"In terms of life annuities, these types of products have become very expensive even at today's rate. Obviously, if rates keep going down they'll be even more costly and if inflation goes up it'll be damaging for investors," he says. "If you can postpone or defer this strategy until later, it'd be a good idea to wait for interest rates to go up."

Tyler says he's attended a number of pension meetings of late and attendees are being told, "interest rates are very low and the traditional formula of using long bonds is punitive for any form of income.

"My own preference is to call it a two per cent world because that's pretty much what's available."

Canadians entering retirement with too much debt

Also of concern, Tyler says he's seeing more retirees saddled with debt at a time when insurance coverage needs rise.

"A lot of people leaving the workplace still have some debt and they have a desire or need for insurance coverage," he remarks. "Those costs are going up and not primarily because of interest rates but due to demographic circumstance. Life insurance costs become more expensive because the insurance companies price insurance off of the long bond yield."

For those retirees shouldering debt, Tyler recommends dealing with it tout de suite.

"I encourage those people, if it's a meaningful amount, to begin paying it down as though interest rates are higher," he says. "When interest rates do become higher, they'll already be accustom to it and in the meantime the principle will decline."

Retirees, savers suffering globally

Also noteworthy, the Bank of England's latest measure of quantitative easing (QE) will reportedly hurt pensioners and savers in that country and it could lead to rising inflation. If a third round of QE is introduced into the American economy, will it have an impact on pensioners here given our tight linkage to the U.S.? The National Bank's Lefebvre says 'no' since the damage has already been done.

"More QE (stateside) is not going to do much to lower interest rates further. If it does come inline, the goal of it will be to lower mortgage rates," he remarks. "It's more in terms of spread for income products than for the nominal yields to drop more. We're already in a damaging situation for income earners as we speak."