Gabe Fransen | April 20, 2022

It is likely that you have heard about rising interest rates and inflation lately. Inflation has topped 8% year over year as of March 2022. We haven’t seen this level of inflation since 1981, when we saw it hit 10.32% year over year. Will we see inflation surpass the mark set in 1981? The Federal Reserve is trying to let that record stand with the announcement of a series of interest rate hikes that is expected to increase the overnight lending rate between banks to 2% or more over the next couple of years.

Since hitting low a point in the summer of 2020, interest rates have been on the rise. The question we want to ask is, “what impact does this have on a retirement plan?”.

I’m sure you have heard it said that bonds are a safe investment, a hedge against market risk. Time and time again we see investment portfolios with some portion of the portfolio allocated to bonds and investors usually tell us that they have bonds because they are risk-averse, so they wanted some safety. For nearly the last 50 years it has appeared that when stocks were taking a hit, bonds were up and when bonds went down, stock prices went back up. As we plan for retirement, we should ask ourselves, “is that a safe bet going forward?”.

In order to find the answer to our questions we have to determine why investors historically have looked to bonds when experiencing volatility in the stock market. Stock market volatility often produces a flight to quality, in the past, with a steady decline of interest rates meant that bond values steadily went up, so it was looked at and leveraged as a “quality” investment for sure. In an environment where interest rates are not on a steady decline, we are now in a different situation than we have seen over the last 4 decades as the following example will show.

If I own a 2% yielding bond with a duration of 5 years issued by your favorite tech company. One year later in our rising interest rate environment another investor that is looking for a new bond to add to his portfolio could find a bond with comparable duration and quality that yields 3 or even 4% – they would want nothing to do with my 2% yielding bond, meaning it has lost value on the open market and I’d need to sell it at a discount to even liquidate it when I want to use it during the downturn of equities, which is the reason I invested in the bond originally. So my safe bet appears not to be so safe.

Now that we have answered the question of if we believe that bond/fixed income will give us the safety that we historically expected, what does this mean for our retirement plan? We believe it means that planning strategies that have been utilized over the last 40 years might not be sufficient. We believe it means that additional scrutiny should be applied to a retirement plan and potentially identifying bond alternatives that may need to be applied to an overall plan to effectively manage stock market risk and times of market volatility.

Many advisors today likely have not guided clients through retirement planning during a period of stock market volatility while interest rates are on the way up. This leaves the legacy planning strategies with the potential to not serve investors as expected throughout their retirement years.

We are proud to and like to provide clients and prospective clients with an alternative approach to investment management and in-depth retirement planning in our ability to serve clients in their best interest in our fiduciary capacity utilizing all the tools available to us as independent advisers.

*https://tradingeconomics.com/united-states/inflation-cpi

*https://www.firstrepublic.com/finmkts/historical-interest-rates