HOW often do you reassess how much money you will need to last you through your retirement? Did you know that this figure will change based on the interest rate environment? Interest rates affect how much money you need to put aside each month for retirement. It also affects what your investments will earn during retirement.

Picture this:

1. Mary retires at age 65 in 2007 with US$1 million. In 2007 Mary could buy a 30-year US Treasury Bond with US$1,000,000 with an interest rate of five per cent and enjoy interest of US$50,000 per year. With no mortgage, no dependents and no major health issues, Mary decides that she can survive comfortably on this US$50,000 per year. The US Treasury is viewed as the benchmark of safety in the finance world. Mary sleeps soundly at night knowing that she has invested in an AA rated bond that has a relatively low probability of default.

2. Mary’s younger sister — Jane — retires in 2021 at age 65 with US$1 million. In 2021 Jane can buy a 30-year US Treasury bond, but she will earn only 1.875 per cent or US$18,750 each year. The US Treasury bond is still viewed as the benchmark of safety in the finance world. However, Jane realises that even with no dependents, no mortgage, and no major health issues, she cannot survive on US$18,750 per year. To get to her target of US$50,000 per year she needs to take much more risk with her hard-earned life savings.

In 2021, to earn five per cent on her US$1 million she effectively needs to invest in “high-yield” bonds which attract higher risk. Jane is conservative and does not want to take this much risk because she is in her 60s and does not think she would be able to recover any loss in capital. She does not understand how US$1 million was enough for her sister but not enough for her.

This is a simplistic example that is for illustrative purposes only and is not intended to provide investment advice. The aim is to simply try to communicate the following key messages:

1. Lower interest rates mean that you will need to put aside more NOW in order to have the SAME quality of life in the FUTURE. Jane needed more money to retire than her sister even though they had similar goals (that is, US$50,000 per year).

2. To help reduce the risk profile of your investments during retirement, invest more during your income-earning years and increase the allocation of your investment portfolio in growth assets such as mutual funds. Jane will have to buy bonds with a higher risk than her sister to earn the same income. This is because interest rates are much lower in 2021.

Low interest rates can make life harder for retirees, however, low interest rates have helped investors who are benefiting from the price appreciation in their bonds and mutual funds. By starting early and adjusting when the need arises, you can position yourself to take advantage of the benefits of low interest rates early on so that you can withstand their wrath later in life.

— Marian Ross is vice-president, trading & investment at Sterling Asset Management. Sterling provides financial advice and instruments in U S dollars and other hard currencies to the corporate, individual and institutional investor. Visit our website at www.sterling.com.jm. Feedback: If you wish to have Sterling address your investment questions in upcoming articles, e-mail us at: info@sterlingasset.net.jm