By Mark Miller

Ultra-low interest rates brought on by the 2008 financial crisis have been great for borrowers, but they've been a nightmare for retirees who depend on low-risk yield on savings to meet living expenses.

Over the past several years, many retirees living on fixed incomes have been forced to cut expenses, eat into principal or rely on higher-risk fixed income investments or stocks.

"Low rates have helped the economy to stabilize," says Barry Glassman, president of Glassman Wealth Services. "It's been good for the banks, housing and the federal government, which has a lot of debt. But that benefit has been at the expense of retirees."

But Glassman thinks the recent rise in interest rates is just the start of a period of substantially higher rates.

"We're coming to an end, in the near term, of the Fed artificially keeping rates low. And high deficits mean the supply of debt from the government won't stop -- but demand from the Fed to buy it will. That means we'll see interest rates heading higher -- not into the stratosphere, but a plateau higher than we're at today. It could take 18 to 24 months, or it could happen in six months."

The recent jump in rates has meant a rout in the value of bonds and some bond funds. But Glassman argues that the longer-term trend will be positive for retirees. "Retirement could be saved for a lot of people if long-term certificates of deposit get to five percent sometime in the two years.

"If retirees can earn five percent with very low risk, that will be very competitive with a higher-risk option like stocks. At that interest rate, there will be a huge wave of demand from retirees who will want to lock in at that rate for 10 years. They'll take money out of money markets and the stock market to do it."

The financial stress retirees have been coping with isn't limited to interest rates, of course. The erosion of traditional defined benefit pensions means that just 20 percent of private sector workers can count on monthly pension income. And Social Security is replacing a smaller percentage of income due to the increasing full retirement age implemented in 1983, rising Medicare Part B premium deductions and more Social Security income is subject to income tax.

Inflation also poses a big threat to retirees. Social Security hasn't paid a cost-of-living adjustment for the past two years and its formula doesn't recognize the higher rates of medical inflation experienced by seniors. Near-zero interest rates on money market funds and certificates of deposit exacerbate inflation's impact.

But if Glassman is right, we could be on the verge of a significant shift in the investment landscape as the baby boomer age wave accelerates and demand for low-risk investments accelerates. As Glassman puts it: "Five percent is the new eight percent."

What will higher rates mean for housing? Not much, Glassman argues. He thinks most people who can refinance their mortgages already have done so. And the government can't keep rates at ultra-low levels indefinitely in hopes that housing will recover. "Housing's recovery will be much more sensitive to employment than interest rates," he says. "Getting the jobless rate down will do more for housing than anything else."

Surprisingly enough, rates have been rising despite a massive push by the Federal Reserve in the opposite direction via the massive $600 billion bond-buying spree known by the short-hand QE2 (second round of quantitative easing in monetary policy, aimed at stimulating the economy). But Glassman doesn't see that getting in the way of rising rates over the longer term.

That's because bond investors are looking down the road to the point in the future when the QE2 bond purchases end. As the program ends, demand for bonds will lessen, but supply will stay high; that will push bond prices lower and yields higher.

"Given how the economy is recovering, investors are already looking beyond the end of QE2 and demanding higher yields today," Glassman adds. "As we hear more good news about earnings and employment, investors are going to be even more confident that there will not be a quantitative easing trilogy --QEIII."

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Personal Finance - Money Manager Thinks Rising Interest Rates Will Bail Out Retirees

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