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Need for Speed or Low and Slow?

Interest rates in the United States have been stuck in low gear for close to a decade.

For some investors, a shift to higher interest rates can’t come soon enough. But for others, puttering along in low gear for the foreseeable future is the best thing that could happen.

With the Federal Reserve’s move in March to increase short-term interest rates to a range between 0.75% and 1%, we shifted into a slightly higher – but still historically low – gear. That surely did not satisfy the need for speed of those longing for higher interest rates.

So who are these speed demons?

In short, anyone looking to their investment portfolio to generate cash flows that can be spent today. That principally means those looking for interest income from savings accounts, certificates of deposit, or bonds. In other words, retirees.

For these individuals, the past decade has been an exercise in patience. Whoever said good things come to those who wait clearly did not encounter an interest rate environment like the one we find ourselves in today. For those yearning for “more normal” mid-single-digit short-term interest rates, the wait still is not over – and likely won’t be for some time.

In a risky move, some of these retirees have transitioned their portfolio to hold more low-quality bonds with higher yields and/or stocks that pay healthy dividends. The goal has been to recreate the cash flows that safer investments once offered.

Unfortunately, these portfolio maneuvers may expose retirees to greater volatility and loss of capital.

Stocks and high-yield bonds are inherently riskier and face greater ups and downs. This could expose vital savings to big drops in value. And if retirees liquidate a portion of their principal each year to meet spending needs, those drops in value – even if only temporary – are locked in as permanent losses.

There are no easy choices. Leave the money parked in safe investments that guarantee an unacceptable return, or migrate to higher returning investments that pose the risk of permanent capital loss?

Higher interest rates would help solve many of these problems.

So who are the folks that don’t mind puttering along in low gear, hoping these lazy interest rates stick around for the foreseeable future?

Predominately younger individuals and those with debt or looking to take on debt.

It’s the recent college graduates, who can take advantage of low student loan rates. It’s the homebuyers, who can lock in jaw-dropping low interest rates for the next 30 years.

It’s those who do not need their portfolio to generate cash flows to support their current spending needs. The U.S. stock market has been unstoppable since the beginning of 2009. However, those advances only benefited people willing and able to accept significant exposure to the stock market. Younger individuals, in general, fit that bill.

Interest rates have been on a leisurely Sunday drive for nearly a decade. Many individuals – retirees in particular – would love to drop the clutch and speed-shift into higher gears, burning the interest rate rubber in the process.

Ironically, it may now be the younger generation shaking their collective fist at the “reckless driving” and “need for speed” of those a few decades older.

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