How a Generation Got Deceived Into Low Yields
Last week, we had the biggest stock market drop in months.
I took the opportunity to remind my parents that they shouldn’t panic when the stock market sells off… they should root for it.
In fact, the further the market falls, the better it is for them.
Let me explain…
My parents have built a portfolio that is skewed toward term deposits and savings accounts. They’ve worked hard and saved religiously.
Their parents, who went through the Great Depression, taught them that term deposits and savings accounts were the most secure places to invest their cash.
They have some exposure to the stock market, but not much. Considering that term deposits and savings accounts pay an insulting amount of interest these days, this is a mistake.
While my parents saved diligently for decades and have lots of money invested in term deposits and savings accounts, they aren’t earning a meaningful amount of income from those investments.
The chart below shows what has happened to retirees like my parents…
You can see (and likely remember) that back in the ’90s, $100,000 stashed away in a savings account produced annual interest income of $4,500 to $6,000.
That is a 4.5% to 6% yield.
Compared with what savings accounts are paying today, those 1990s rates seem like absolute windfalls.
In 2020, $100,000 invested in a typical savings account produces a pathetic amount of interest: $220.
That is an annual return of 0.22%, which is around one-fifth of 1%. It is basically a rounding error away from zero.
Interest Rates Aren’t Getting Better Anytime Soon
At the end of the 1990s, a $100,000 savings account balance was able to generate a 6% annual rate of return, or $6,000 of interest income.
In 2020, if a retiree wanted to generate $6,000 from a savings account, they would need to start with $2.74 million.
That means a savings account needs to be 27.4 times larger ($2.74 million vs. $100,000) in 2020 to generate the same amount of interest.
For retirees like my parents who are in their golden years, it’s a harsh reality…
My parents based their retirement planning on expectations that were set in the 1980s and 1990s when they were in their peak saving years.
Instead, they now see that they needed to have saved 27.4 times more money than they expected in order to generate the retirement income they wanted.
This isn’t a new state of affairs. Interest-bearing accounts have yielded very little for the past decade. We haven’t seen interest rates this low in recorded history.
Unfortunately, the U.S. Federal Reserve has made it very clear that interest rates aren’t going higher anytime soon. It foresees interest rates staying at zero through at least the end of 2023.
This is why I have been telling my parents, who are sitting on savings and term deposits that are paying nothing, to cheer for stock market declines.
After all, as stock prices drop, dividend yields rise.
My parents currently have a very, very modest allocation to the stock market. They could and likely should have more.
And the further the stock market drops, the greater the opportunity they have to build out a diversified dividend-paying portfolio that provides some real yield.
Plus, it offers a chance to score some capital gains when the market eventually rebounds… as it always does.