At the conclusion of its March 15–16 Federal Open Market Committee (FOMC) meeting, the Federal Reserve raised its federal target funds rate by a quarter point. It was the first increase since December 2018, but it wasn’t a huge surprise. Fed Chair Jerome Powell had already said we should expect this move, and the market has priced-in several future hikes this year.

Along with interest rates, inflation remains a related topic of conversation … not to mention the economic toll and humanitarian tragedy being wrought by Russia’s horrific warmongering.

To our distress, there is only so much we can do to alleviate the heartbreaking news coming out of Ukraine. But as your investment consultant, we at Conrad Siegel can at least help you put these interrelated influences into thoughtful context. In this column we will focus on interest rates and inflation.

Our core investment philosophy remains unchanged, we help people navigate their financial interests across time and through various market conditions. The news may be new, but the timeless tenets driving our patient and personalized advice are enduring and, if anything, even more relevant during periods of increased uncertainty.

What’s Up With the Fed Rate?
Almost everyone is familiar with interest rates. That said, far fewer know what to make of the Fed’s target funds rate in particular. Everyone from economists, to politicians, to the financial press talks about the Fed’s target rate. As the central bank for the United States, the Federal Reserve is tasked with setting monetary policy to promote “maximum employment, stable prices, and moderate long-term interest rates … thereby supporting conditions for long-term economic growth.” In this supporting role, the Fed uses its target funds rate as one of many “levers” to achieve its aims.

When the Fed increases the target funds rate—such as the recent 0.25% increase—it’s actually establishing a range of rates. Current rates are thus 0.25%–0.50%, up a quarter-point from 0.00%–0.25%. Banks and similar institutions then target this range when they lend overnight money to one another. They use these hyper-short-term loans to collectively maintain their required cash reserves, or to otherwise raise immediate operational cash.

When the Fed increases the target funds rate it is hoping to reduce the flow of excess cash or stimulus in the economy. The FOMC also indicated that it will be reducing its Treasury and Agency debt holdings, further restricting the money supply. These moves are expected to help temper inflation and excessive consumer demand.

However, we must emphasize: No single entity can just flip a switch to power off the economy or slow inflation, but the Fed is in a relatively strong position to encourage long-term desirable economic outcomes. Often, its actions will trickle down to other types of loans and move them in a similar direction, for the same purpose. But not always, and rarely across the board. As in any complex system, any given move interacts with countless others, with varied results. This is especially so globally, as most countries have central banks of their own.

The Fed Target Rate Isn’t Every Rate
Rising rates are meant to help unwind earlier stimulus programs, and manage rising inflation by tinkering with the cash flow in our banking systems. But as an admittedly blunt tool, there is an even more tenuous connection between the Fed’s rates and the interest rates you personally pay or receive.

For example, existing fixed-rate debt such as home and student loans may not be immediately affected by rising rates, while free-floating credit card debt is more likely to creep quickly upward in tandem with the Fed’s rates. Similarly, you may or may not receive higher rates on interest-bearing instruments such as bonds, CDs, bank accounts, etc. That’s because it’s the banks and similar entities, not the Fed, who set these rates. Savers shouldn’t get their hopes up too much as banks have little incentive to raise the interest they pay on deposits because they simply don’t need to attract additional money.

Time will tell whether this or future Fed rate increases contribute to lower inflation and a healthy economy. Similar actions have been known to help in the past. But of course, each era comes with its own challenges and opportunities. Current events are certainly no exception to this rule. In particular, current global strife and sanctions on Russia may well have a much larger influence on inflationary risk than what the Fed can and cannot do about interest rates. As always, please reach out to us with any questions or concerns.

Marketing execs have often tried to slant products toward women using an outdated strategy known as “Shrink It and Pink It”. This strategy involves taking a known product and making it smaller and coating it in pink or other pastel colors believed to be more appealing to a female market.

The athletic wear industry used to engage in the “Shrink It and Pink It” methodology of marketing to women until it realized something that should have been obvious from the beginning: women’s bodies differ from men’s. Therefore products should be designed for those differences; not just painted pink. So they opted to engage in designing products for women based on their specific needs.

Just like the design of athletic wear, designing a financial plan for a woman has to be done with an eye towards those specific challenges that women face with investing and planning. Of course, every woman is different, but research shows certain issues tend to be ubiquitous.

When it comes to personal finance, women face an uphill battle. It wasn’t that long ago that the handling of household finances was seen as a man’s domain. In fact, women couldn’t even apply for credit cards in the United States until 1974^1. Homemakers, a historically female-only role, only became eligible to make full IRA contributions in 1997^2. Many women feel a cultural stigma surrounding financial conversations. In fact, one recent study found that a majority of women polled would rather talk about their own death than about personal finances^3.

But these conversations are extremely important, especially considering the conundrum facing most women when planning for retirement. In a cruel irony there exists two inescapable factors that greatly affect women’s retirement planning.

The first is the wage gap. It’s no secret that there exists a pervasive wage gap between what women earn and what men with similar education and experience earn. This is a serious problem that needs to be addressed on a societal level. However, when planning for retirement, a woman is focused on solving her own individual problem. And if she’s earning less than her male counterparts, she is already at a disadvantage, having less disposable income to allocate towards retirement savings.

The second part of this conundrum is the fact that women live longer, and therefore tend to have longer retirement periods. Consider the difference in the assets needed to fund a retirement from age 65-80 versus from age 65-95. Longer life requires much more in the way of retirement savings to fund income needs.

And living expenses over a longer time period aren’t the only concern -women spend more on healthcare. On average, out-of-pocket healthcare costs through retirement trend 39% more for women than those for men^4.

So when it comes to financial planning, women actually do have unique needs, making it important to acknowledge and explore with both close family and a trusted financial professional. Determining the right strategies for your unique situation is the key to ensuring you have an effective long-term solution to pursue a comfortable, secure retirement.

At Conrad Siegel, all of our consultants understand the unique planning needs of women and incorporate them into your financial plan. No shrinking or pinking needed!

^{1 Time.com, https://time.com/nextadvisor/credit-cards/ruth-bader-ginsburg-credit-card-legacy/, November 13, 2020
2 Chicago Tribune, https://www.chicagotribune.com/news/ct-xpm-1998-03-03-9803030185-story.html, March 3, 1998
3 Age Wave and Merrill Lynch, Women & financial wellness, 2019
4 Age Wave estimate, based off Yamanoto, D.H., Health Care Costs – From Birth to Death, Health Care Cost Institute Report, 2013; HealthView, Retirement Healthcare Costs Data Report, 2016-2017}

Looking for an investment that aims to keep pace with inflation? I bonds might be for you. They are sold exclusively by the U.S. government through the www.TreasuryDirect.gov website.

Investors in these inflation-protected U.S. savings bonds are guaranteed to recover their principal plus inflation over a maximum of 30 years. I bonds offer a fixed rate, plus an inflation rate that adjusts semiannually. The inflation rate is linked to the Labor Department’s CPI-U, a measure of urban inflation. I bonds allow you to defer federal taxes until the bonds are redeemed, at which point you will receive a 1099. Additionally, I bonds are exempt from state and local taxes. There is also an interest rate floor of 0.0%, meaning your principal is protected in the unlikely event of deflation.

Today, the yield on a regular U.S. 30-year Treasury bond is about 2.25%. I bonds now offer an initial annualized yield of 7.12% (this is made up of a fixed rate at 0% and the semiannual inflation adjustment of 7.12%). At this rate, investors are keeping pace with the most recent inflation reading of 7.5% over the last 12 months. Meanwhile, yields on conventional Treasury bonds are now negative when inflation is taken into account. This demonstrates an advantage of I bonds.

A downside to I bonds is that each individual investor can purchase a maximum of $10,000 per year and would need to establish an account via the Treasury Direct website. If you opt to receive your Federal tax refund in I bonds, you could add an additional $5,000 annually. Holders of I bonds are barred from cashing them in for the first 12 months and you will lose three months’ of interest if the bonds are redeemed within the first five years. Lastly, the annualized inflation rate is variable, resetting every 6 months (keep in mind that the Federal Reserve’s stated goal seeks to achieve inflation that averages 2 percent over time).

While Conrad Siegel cannot purchase I bonds for our clients, I bonds could be an attractive alternative to low yielding bank savings account balances that are embarked for longer-term retirement or education funding goals. If you would like to learn more, reach out to our team.

Clearly, there is a lot to think about when planning for retirement. While we have a degree of control over many of the choices involved, there’s one big wild card called sequence of return risk.

Sequence of return risk is the risk that you’ll encounter negative investment returns in early retirement. This is an important consideration, because the sequence – or order – in which you earn your returns early in retirement can have a significant impact on your lasting wealth. Simply put, a retirement portfolio that happens to experience positive returns early in retirement will outlast an identical portfolio that must endure negative returns early in retirement. This is true even if the long-term rate of return for both portfolios are identical.

Since nobody can predict which return sequence they’ll experience early in their retirement, every family should prepare for a range of possibilities in their retirement planning.

The Significance of Sequence of Return Risk

It’s no secret that global stock markets are volatile. While long-term average annual returns may be in the range of 7% for a diversified portfolio of global stocks and bonds, markets rarely deliver average returns in any given year. Rising one year, falling the next; we never know for sure how far above or below the average each year will be.

During your career, you’re mostly spending earned income, while adding to your retirement portfolio. As long as you stay the course benefiting from the upswings and enduring the downturns – tolerating market volatility is just part of the plan.

In fact, when you’re still accumulating wealth, market downturns give you the opportunity to buy more shares than you otherwise could when prices are higher. When the market recovers, you then have more shares to recover with, which ultimately strengthens your portfolio.

But then, you stop working, and start spending your reserves. This has the opposite effect. Now, when the stock markets decline, you may need to make a withdrawal from a portfolio that has declined in value. This underscores the need for a broadly diversified asset allocation of stocks and bonds. When stocks are down, we want to source withdrawals from the part of the portfolio that has maintained its value. Selling an asset when it is down, means you will have fewer shares with which to participate in the eventual recovery. This hurts your portfolio’s staying power.

Sequence of return risk Illustrated

Consider two hypothetical retirees, Joan and Jane:

• Both retire at age 65 with identical $1 million dollar stock portfolios.
• Both start withdrawing $50,000 annually at the start of each year (not adjusted for inflation).
• Both earn the same 7% average annual returns over their 25 years in retirement.

With so much in common, you might assume their portfolios would perform similarly. But what if Joan happens to enter into retirement during a horrible market? Let’s imagine her portfolio returns –30% and –20% in her first two years, while Jane earns 7% both years, and (implausibly) every year thereafter.

Markets recover nicely for Joan after two years so, again, she ultimately earns the same average 7% annual return as Jane. But Sequence of return risk takes a heavy toll on Joan’s remaining shares. She ends up with only about $150,000, while Jane’s portfolio grows nicely to around $2 million.

Managing the Sequence of return risk Wild Card

Sequence of return risk should NOT change your overall approach to investing. As the recent past has clearly shown us, you never know what’s going to happen next. Stock market corrections typically occur
without warning, while some of the strongest rebounds arrive amidst the darkest days.

So, whether you’re 40, 60, or 92, we still recommend building and maintaining a low-cost, globally diversified portfolio that reflects your personal goals and risk tolerances. We still advise against trying to pick individual stocks or react to current market conditions. We still suggest you only change your portfolio’s asset allocations based on life events, not market events.

What can you do to mitigate Sequence of return risk if it happens to you?

Keep working. If you are willing and able, you might postpone retirement, or even return to the workforce. Even part-time employment can help offset an ill-timed sequence of negative market returns.

Spend less. Since your portfolio is most vulnerable to negative sequence of return risks early in retirement, you may want to initially spend less than planned, to give your portfolio an opportunity to rebound.

Tap other assets. When you retire, you typically have several sources of income to draw from. You may have emergency cash reserves, Social Security, or pension plans. Your investments are usually divided
between stocks and bonds. You may have equity in your home. If you encounter a negative stock market in retirement, you might be able to tap a combination of your non-stock assets for initial spending needs.

Consult with a financial advisor. Sequence of return risk is usually not the only consideration at play in retirement planning. There are taxes to consider and estate planning goals to bear in mind. There are carefully structured investment portfolios to maintain. All these needs speak to the value an experienced advisor can add before, during, and after this pivotal time in your financial journey.

At Conrad Siegel, we help our clients prepare for and mitigate Sequence of Return Risk within the greater context of their goals for funding, managing, spending, and bequeathing their lifetime wealth. Please be in touch today if we can help you with the same.