How to Invest for Retirement in a Low-Interest Rate Environment

Burton Malkiel
Burton G. Malkiel June 1, 2016

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How can you invest for retirement in a low-interest rate environment? One answer is to invest in bonds. Learn why many retirees choose to invest in bonds, what the risks are, and how to buy them.

Investing in a bond fund can help diversify your portfolio. This week’s Goldstein on Gelt podcast gives a link for a video about bond laddering and an article that explains how bond funds can increase your portfolio’s diversification.

Professor Burton G. Malkiel of Princeton University, bestselling author of A Random Walk Down Wall Street, takes the idea of investing at low risk further. He recommends three tools that may help you to invest for retirement in today’s low-interest environment and shares his predictions for inflation and interest rates.

Watch A Random Walk Down Wall Street on YouTube.

Read the Transcript

Interview with Burton Malkiel

Professor Burton Malkiel of Princeton University, author of A Random Walk Down Wall Street, discusses how retirees and other low-risk investors should invest in today’s low-interest environment. How can they invest conservatively without losing out to inflation?

Douglas Goldstein: Professor Burton Malkiel is the author of A Random Walk Down Wall Street. Professor Malkiel, I would like to ask a question about an article that you had written around five years ago about low interest rates. Things haven’t really changed much since then. The problem is that as a financial advisor, I’m helping people that have retired get income, but nothing is available that seems reasonable. What do you think retired people should be doing for income these days in a low interest rate environment?

Burton Malkiel: It’s very difficult because we really live in an age of what might be called “financial repression,” where in all of the developed world central banks have driven interest rates down to basically zero and in some cases to actually negative. So I’m afraid there is no easy, no-risk solution. I think that unfortunately what this means is that retired people are going to have to take on some amount of risk and fortunately, there are some things available. Let me mention three of them.

First of all, while any sovereign bond that’s guaranteed by the government is really off the table because there’s no interest there, corporate bonds (and I’m not talking about junk bonds here, I’m talking about corporate bonds of good quality companies) do give you a reasonable yield. It’s not high, and we’re in a low interest rate environment. Fortunately, we’re also in a low inflation environment, but corporate bonds are one thing. Secondly, there are preferred stocks. They are not bonds, but they have a fixed interest rate. Just to give you an example of one of these, the Bank of America is one of the leading banks in the United States. They are just coming out with a preferred stock issue, and the interest rate will be about six and one-eighth of a percent. Now it’s not like a U.S. treasury bond. It’s got some risk, but my sense is that that’s a risk that is reasonable to take, and I think that’s one way you can get some reasonable return. Finally, for those who want to take on even more risk, I think that there are many dividend-paying growth companies in the world, where you can get a dividend return and the dividend is growing over time. Let me give you one example in the United States. We have AT&T, a blue chip telephone company. AT&T bonds yield about 4%. They’re fine. These are the corporate bonds I was talking about, but AT&T stock, which is riskier than the bond, yields about 5% and the dividend has grown over time. So for those who want to go out a little further on the risk spectrum, stocks of dividend growth companies, blue chip companies that have reasonable dividends, and the dividends are growing is another alternative. So I would say corporate bonds for one, these preferred stocks, such as the Bank of America one I just mentioned, or dividend growth stocks would be my advice. It’s not perfect advice because it’s much more risk than just buying U.S. treasury bonds, but unfortunately, given the situation we’re in today, that’s about the only reasonable alternative for retired people.

How Does Inflation Affect Retirement?

Douglas Goldstein: Before we talk about the specific assets that you mentioned, let’s talk about inflation. Inflation, it seems to me, is a very political figure that a lot of people talk about and in particular, they always like to break it up and they’ll exclude something. One of the areas that for young people is not a problem, but for older people is, is inflation in the cost of health care. Regardless of Obamacare and the politics on that, it’s costing more and more money. So we say “it’s very low inflation,” but really people who are well into their retirement are paying a lot of money there. Doesn’t that count?

Burton Malkiel: You’re absolutely right that the market basket for retired people, the prices of those goods, are rising faster than the general inflation rate. I do think we’re going to be in the low inflation environment for a long period of time because the world is awash with goods and manufacturing capacity. But particularly in the medical area, this is where the rate of inflation is going to be even higher than the general level of inflation. It suggests again that you buy a U.S. treasury 30-year bond at 2% and you’re not going to have a positive real rate of return after inflation. So again, what this means is unfortunately that you’ve got to go out. There’s no no-risk way of dealing with this. You’ve got to go out to some of these 5 or 6% return securities that I was mentioning before.

Douglas Goldstein: Let’s focus more on those risks. At the beginning of the show, you mentioned a few tools that retirees could use: corporate bonds, preferred stocks, and dividend-paying stocks. I’d like to dive into this a little bit more. Let’s go in reverse order. As far as dividend-paying stocks, I know you’re disclaiming your comment by pointing out the risk, but let’s look at the example you give. When I was in stockbroker school, when I started 25 years or so, AT&T was considered a widow’s and orphan’s stock. Then, when I look back not in the very far history, at one point it was trading around 60, and a couple of years later it was at 20. How can a retired person live with that level of risk? Even if you and I can talk about long-term investing, they’re saying, “I can’t lose two-thirds of my portfolio.”

Burton Malkiel: I don’t think that all retired people should have simply common stocks. I only would like to do that for a part of what I would call the income portfolio that people need. If you again go back to the middle one that I have mentioned, the Bank of America preferred, I think there you’re going to have a much more stable value. You’re absolutely right that common stocks are going to fluctuate. That’s why I mentioned it as the third rung, because they’re going to be quite volatile, less volatile than the market as a whole, but still going to be quite volatile. But I still think for a third of one’s portfolio, probably, it is still reasonably sensible to do. If you are so nervous that anytime the stock goes down two or three points, then clearly that’s not for you. Go to the bonds or the preferred stocks. But for those who go in with their eyes open and know that there’s going to be that volatility, I think that that’s reasonable because, and this goes back to your question on inflation, the thing about the dividend-paying stocks of these blue chip companies is that the dividends do grow over time and the fixed income does not grow over time. So again, there are risks and risks, and at least you get paid for that volatility in terms of the possibility of the dividend growing over time to meet the inflation in things like healthcare costs.

What Happens if Interest Rates Go Up?

Douglas Goldstein: Let’s talk about another risk. Specifically, I’d like to now go to your second choice, the preferred stocks. Today, 6 and 8% sounds great. We would all like to get that, but would you say that preferred stocks like this are comparable to a long-term bond? And if interest rates do move up, not necessarily over the next 12 months, but let’s say in the next 3, 4 or 5 years, what would happen to the price if someone buys a $25 preferred stock?

Burton Malkiel: You’re again absolutely right. If interest rates move up, it is likely that the price will decline. Like I said at the beginning, I don’t have a perfect solution, but I would say this: My sense is that interest rates are going to be low for a much longer period of time than many people anticipate. Again, the world is awash in manufacturing capacity. We have very slow growth all over the developed world, and even the developing world is slowing down. I think you’re right. There is a risk if interest rates rise sharply, but I do not expect that to happen. They’ll go up a little, but I think they’re going to be lower for longer.

Douglas Goldstein: The point we are addressing here is that normally, with fixed-income investments, and preferred stocks are like that, when interest rates do move up the principal value of these investments drops, even though they may continue to pay their dividend. Now let’s finalize the discussion by going back to your first point, which was about corporate bonds. One of the problems that individuals have with buying real quality corporate bonds is that you’re not getting much yield above the banks, so you have to lower the quality. I’m not talking about junk bonds because I would certainly not think that it’s appropriate for most people to buy individual junk bonds. But they’re going to look in the triple B, or triple B minus rating. A lot of oil companies, for example, are there these days because the commodity of oil has dropped in value and people are afraid of that. How can someone put together a reasonable corporate bond portfolio that’s not going to expose them to huge interest rates risk and/or of default risk?

Burton Malkiel: I believe that what this means is that one would have to be quite well diversified, and it almost requires the person to think of buying a fund. There, I would say to try to get the fund or the exchange traded fund. There are mutual funds where you’d go to a mutual fund company, like Vanguard, and buy the fund or there’s an exchange traded fund, which trades on the stock exchanges of the world like an individual stock, and these are very well diversified. So I would say an investment grade corporate bond mutual fund or exchange traded fund, and here my one piece of advice is to get one that has a very low expense ratio. All of us who give investment advice have to be very modest about what we know and don’t know. But I’ll tell you the one thing about investing that I am a hundred percent sure of, and that is the lower the fee I pay to the purveyor of the investment service, the more there’s going to be for me. So looking for a fund or an ETF that is sponsored by a company like Vanguard, which is the biggest mutual fund company in the world, is where I would go. But you have to do it with a fund because you’ve got to be diversified while these oil companies could well default. So you want a very well-diversified bond fund even if it is investment grade.

Douglas Goldstein: Just to add on to the important understanding of bond funds, as opposed to individual funds, the fund itself doesn’t have a maturity date. In other words, if you put on $100,000 it’s not like the fund owes you that money, whereas if you were to buy an individual bond, assuming they won’t default, they will pay you back the money at that maturity date. And one disclaimer that I want to make for everyone listening: both myself and Professor Malkiel are not making specific recommendations for the Bank of America, AT&T stocks, or the bonds. These are all just examples. Be sure to speak to a qualified investment advisor before investing anywhere. Professor Malkiel, in the last few seconds, how can people learn more about your ideas?

Burton Malkiel: I have an 11th edition of my book A Random Walk Down Wall Street, which is just out this year in paperback and that’s certainly one way to do it. There’s an edition in Hebrew, but it’s not the most recent edition, so I think that probably will be translated into Hebrew but for right now, I would say the paperback edition, which has a 2016 publication date.

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