Sunday, September 16, 2012

Retirement Money and Federal Reserve Decisions

In 2012, Ben Bernanke, the chairman of the Federal Reserve, announced that the Fed was going to begin purchasing $40 billion a month in bonds "as long as necessary" in order to stimulate our sluggish economy.  This decision was referred to as QE3, or the third round of Quantitative Easing.  The effects of this decision on the financial markets were immediate, with stocks surging.

However, many retirees and Baby Boomers who plan to retire during the next few years are concerned about the effect QE3 will have on their retirement plans.  Will this help or hurt retirees?  The truth is that it could do either, depending on your personal circumstances.

The Wealth Effect of the Federal Reserve Decision

According to an article in The Washington Post, called "The Wealth Effect," the goal of the Federal Reserve is to give Americans the feeling of prosperity.  This is achieved when stock prices and home prices rise.  People perceive that they have more money, which makes them more willing to spend.  The more Americans spend, the more manufacturing and other businesses improve.  This creates more jobs, when everything goes as planned.

When interest rates go down, stock prices tend to go up.  This happens because many investors will reduce their investments in low-yield bonds and put more money into stocks.  Stocks are more risky, but they often provide greater returns.  In addition, low interest rates on loans make it possible for corporations to have greater profits, so they have more money to reinvest in their businesses.

Joseph Gagnon of the Peterson Institute for International Economics estimates that consumer spending increases by about 3 to 5 cents for every $1 increase in stock prices.  This, of course, has a stimulating effect on the economy, which provides jobs and opportunities even for those people who do not own stocks.

Another way low interest rates stimulate the economy is by making home loans more affordable.  The idea is that this stimulates home sales, causing home prices to rise.  Of course, if people have difficulty finding a mortgage, home prices do not rise as much as the Fed would like.  However, any rise in home prices can benefit homeowners.

In general, the Federal Reserve expects that people see their investments, including retirement savings, increase in value whenever they lower interest rates and pump money into the economy.  In addition, when homeowners see their home values increase, it makes it easier for them to sell their homes, take out a second mortgage or, in the case of retirees, get a reverse mortgage.  All of this makes it sound like the Fed decision is 100 percent beneficial.  However, the picture is not entirely rosy when the Fed stimulates the economy.

The Effect of the Fed Decision on Retirement Income

Millions of Americans who retired during the 1980's and 1990's planned to supplement their meager Social Security and pension benefits with additional income from their retirement savings.  However, while many of these retirees were initially able to put their money into safe bank CD's and bonds which paid six percent or more in interest or dividends, those same retirees are now lucky if they get a two percent return. 

When interest rates began to drop about in 2007, some of these retirees put their savings into the stock market. They were devastated when the markets crashed.  Often, they pulled what was left of their savings out of the stock market and returned it to the bank.  Of course, after five years of low interest rates, often combined with the loss of part of their principal, these retirees were left with much less income than they ever expected.

For retirees who are dependent on interest income to supplement their retirement income, the Fed's decision to keep interest rates extremely low has been a devastating blow.  This decision has made it much more difficult for retirees to manage their money so that it will last the remainder of their lives.

In addition, the Fed decision could eventually cause runaway inflation, if it is not reversed.  This would cause expenses to rise for retirees (and others), making it even more difficult for them to have sufficient income to meet their needs.

On the other hand, when the Fed succeeds in their goal of causing both the stock market and housing prices to rise, the increased wealth helps those retirees who own either stocks or a home.  As you can see, whether Fed decisions benefit you or not depends on your personal circumstances.

Either way, when you make your retirement plans it is important that you assume that interest rates will remain low for at least the next few years.  Even if the Fed slightly raises interest rates starting in 2015 or 2016, as planned, it could take years before the returns are adequate to help retirees live off the income.  New retirees should use only a minimal amount of their retirement savings during the early years after they stop working, in order to survive financially in later years.

If you are interested in additional ideas for financial planning, where to retire, medical issues and changing family relationships, use the tabs or pull down menu at the top of the page to find links to hundreds of other helpful articles.

You may also be interested in reading:

Do You Need a Millions Dollars to Retire?
Best Places to Retire in the United States on $100 a Day
Retirement Deferred by Parent Student Loans
Retirement Income from Annuities or Investment Income
Cheap Places to Retire

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