The Fed Just Increased Interest Rates Again

On March 22, 2023, the Federal Open Market Committee (FOMC) raised the Federal Funds Rate again in an attempt to slow down the economy and curb inflation. The rate now stands at a target range of 4.75% to 5%, the highest since 2007. This rate is crucial as it determines overnight lending rates between banks.

For individuals, it affects the interest crediting rates offered by banks on certificates of deposit (CDs) and money market accounts. On the liability side, it can influence the interest rate charged on credit card balances.

For those in or approaching retirement, higher interest rates on fixed-income investments mean higher investment returns, which is generally beneficial. However, if inflation consumes all of your investment returns, you’re not making progress. Ideally, we hope for higher real interest rates, which reflect what you can earn after accounting for inflation.

Interest rates are now significantly higher than they were a year ago. Ensure that the portion of your portfolio designated as “conservative” is working diligently for you. Avoid leaving assets in a sweep account earning minimal interest. This practice is how many large firms like Schwab generate billions of dollars in revenue. They credit sweep accounts with a meager interest rate and invest the assets in higher-yielding instruments.

Consider locking in a bank CD at a higher rate. As the challenges of Silicon Valley Bank and Signature Bank remind us, we should only invest up to $250,000 per depositor, per insured bank, for each account ownership category.

You can also utilize high-yielding money market accounts when you require access to liquid assets.

Married couples should think about how they are invested across both spouses’ retirement portfolios. For example, let’s say a wife has $500,000 in a stable value fund in her 401(k), earning a guaranteed 3% interest over the next year. This is a reasonable investment for someone who doesn’t want to lose any principal. Let’s also assume she has access to an S&P 500 index fund.

Furthermore, let’s say her husband has $500,000 in an IRA invested in an S&P 500 stock index fund, and he could purchase a one-year bank CD yielding 5%. If they conducted the fixed-income investing in the husband’s IRA (rather than the 401(k)), they could generate a higher investment return on the conservative portion of their portfolio. In fact, they could earn an additional 2% rate of return ($10,000!) while maintaining the same asset allocation within the household.

Higher interest rates also increase income annuity payouts. Now that you can access annuities without the traditional commissions of 3-5% through a fee-only Registered Investment Adviser (RIA), the payouts are even higher. While most people think about lifetime income annuities, you can also purchase them for a specified period. These are called period certain or term certain annuities. For instance, if you need cash flow in your early years of retirement before claiming Social Security, you could buy this income with an annuity payable for a specific period, like eight years.

Higher interest rates reward savers, and this is a good thing for retirees and those nearing retirement.