Interest Rates Have To Go Up. The "Bond King" Says No
FORECASTS & TRENDS E-LETTER
IN THIS ISSUE:
1. PIMCO’s Bill Gross Says Interest Rates Are Going Lower
2. Social Security at 62? Not a Good Idea For Most!
The prevailing view on Wall Street and Main Street is that medium and long-term interest rates have to go higher in the months and years ahead. Interest rates have to get back to “normal” at some point, so we’re told. Yet in the last several months, yields on 10-year Treasury notes and 30-year Treasury bonds have fallen rather significantly. What’s up with that?
Last week, PIMCO’s founder Bill Gross – aka the “Bond King” (because he runs the largest bond fund in the world) – predicted that medium and long-term rates are going down, not up. For reasons I’ll explain below, Gross makes a case for falling yields going forward. His latest prediction is clearly out of step with the mainstream, but I thought you would appreciate his thinking, even if you disagree.
Next, some new data reveal that over 40% of retiring Americans start taking Social Security benefits at age 62, which means they will get less money overall than if they had waited until later. In most cases, you should delay taking Social Security benefits until age 70 if possible. Given that we are in the investment/financial planning business, we are often asked for advice on when to take Social Security.
As it turns out, the best article I’ve ever read on this subject appeared over the weekend in RealClearMarkets.com. The piece is written by award-winning author and lecturer John F. Wasik. Today, I’ll reprint that article in its entirety. Even if you’ve already had to decide when to take Social Security, this article would be good to pass on to others who are nearing Social Security eligibility.
Interest Rates Have To Go Up. The “Bond King” Says No
We all know that long-term interest rates have to go up, perhaps significantly, before too long, right? That is the prevailing view on Wall Street and Main Street. That’s what the financial futures markets are pricing in. The Fed is tapering its bond buying program that was designed to keep long-term rates low and intends to stop QE altogether before the end of this year.
Yet in the last several months, Treasury bond yields have fallen rather sharply, as you can see in the 30-year T-bond chart below. When yields fall, the value of bonds goes up. So why are bond yields falling when most agree that long rates have to go up in the future?
The bellwether 30-year Treasury bond yield has tumbled from a high above 3.7% in March to 3.3% today. That’s a significant move given the prevailing view that rates have to go up. Not so says PIMCO’s Bill Gross. He and PIMCO believe that the next trend in long rates is DOWN, not up. I’ll explain their latest forecast below.
For those not familiar, PIMCO is one of the largest investment management firms in the world. PIMCO stands for Pacific Investment Management Company, LLC headquartered in Newport Beach, California with some 2,400 employees worldwide. PIMCO reportedly had almost $2 trillion in assets under management at the end of last year.
Bill Gross is PIMCO’s outspoken founder, CEO and the portfolio manager for the world’s largest bond fund – the PIMCO Total Return Fund which had over $292 billion in assets at its peak. Mr. Gross is most often referred to as the “Bond King.” However, after leading the industry in returns since 1987, the Total Return Fund underperformed over the last year or so. As a result, the fund has seen redemptions which have reduced its size to $230 billion as of the end of April. Still, it remains the largest bond fund in the world.
I tell you all of that to get to my main point today. Each year, PIMCO holds what the firm calls its “Secular Outlook Forum” during which investment professionals from its 13 global offices gather for an examination of critical factors affecting economies and markets over the next three to five years. The 2014 Forum was held earlier this month, and here are the conclusions.
First, the PIMCO Forum concluded that the global economic recovery will continue, led by the US, but that overall growth will be very slow over the next three to five years. The primary reason that economic growth will be slow, according to PIMCO, is that global debt is at an all-time high. The Bank For International Settlements (BIS) just reported last week that global debt outstanding hit a new record above $100 trillion in 2013!
Second, because of its outlook for continued weak global economic growth, PIMCO now expects that intermediate and long-term interest rates will FALL over the next several years. Yes, you read that correctly. They believe that the 10-year Treasury note and the 30-year Treasury bond rates can and will move lower, not higher over the next three-to-five years.
While not making a prediction, PIMCO’s Bill Gross said it’s not inconceivable that the 10-year T-note yield – currently just above 2.5% – could fall as low as 2.0% in the next few years. If that were to happen, it would imply that the yield on 30-year T-bonds would fall well below 3% again as it did in the spring and summer of 2012.
Mr. Gross adds that he thinks it will be several more years before the Fed and other central bankers around the world abandon ZIRP (zero interest rate policies). Most forecasters, and the markets, expect the Fed to begin raising interest rates by mid-next year. Mr. Gross disagrees.
So what are we to make of these latest macro predictions by PIMCO? There are a lot of really savvy folks who work with Bill Gross at PIMCO, so I’m not going to say their latest forecasts are wrong. What I will say is that I know of no other respected forecaster that is predicting interest rates remotely that low in the next few years.
But when the manager of the largest bond fund in the world tells you that interest rates are going even lower, you have to stop and consider that possibility. That’s why I try and stay on top of developments in the financial world. Otherwise, you would probably never hear about such predictions.
We’ll see. I will keep you posted.
Next, here’s the best article I’ve read on when to begin taking Social Security benefits:
Social Security at 62? Let’s Run the Numbers
For many retirees, Social Security benefits are seen as hot money on the table, to be devoured as soon as possible. But as with preparing and savoring a fine meal, a careful approach and delayed gratification may yield the highest rewards from the program.
Many financial planners advise that you wait as long as possible before receiving benefits. Despite this, a sizable number of Americans who have reached 62 — 41 percent of men and 46 percent of women — apply for Social Security at 62, the earliest age at which you can take payments. The way Social Security works, this will lock in the lowest possible payment for life.
The “early” approach works if you need the money immediately. A lot of people, especially the millions who haven’t saved much, do need it. But the decision would penalize you over time. You would be passing up a progressively higher benefit available in each of the next eight years. This period includes when you reach what Social Security calls your “full retirement age” — 66 for those born between 1943 and 1954, as old as 67 for later arrivals — and what might be called a bonus period after that, ending at age 70.
Individual dollar totals over the course of a retirement are never easy to predict, but unless your current health prognosis is gloomy, the longer you expect to live, the more sense it makes to delay benefits.
If your full retirement age is 67, then by receiving Social Security at 62, you take a haircut on potential future payments of 30 percent compared with a 6.7 percent reduction at 67. For those waiting until age 70, Social Security offers an 8 percent yearly rate of increase in payments (not including cost-of-living adjustments) over taking benefits at 62. That easily beats what you would earn in government bonds these days.
The “wait to take” strategy makes even more sense when you consider longer life spans. On average, women reaching age 65 today can expect to live to age 86 and men to 84, according to the Social Security Administration. About a quarter of this group will live past 90. If you’re relatively healthy and there’s longevity in your genome, you’ll probably need the extra money.
Then there is the cost-of-living adjustment, making Social Security one of the few inflation-adjusted retirement benefits around — at least for now. But keep an eye on Washington: Several proposals have been floated to trim the cost-of-living adjustment, though none have made it through Congress and all are likely to be extremely unpopular among current retirees and near retirees.
Prof. Richard H. Thaler, the University of Chicago behavioral economist and Sunday New York Times columnist, said that with most people claiming Social Security benefits within a year of eligibility, “they are passing up a chance to increase the most cost-effective way to get more inflation-protected annuity income, which is to delay claiming. For those who are strapped for cash, it may be better to start drawing down their 401(k) assets sooner and keep building up their Social Security credits.”
The extra dollars gained add up in a profound way for those who delay benefits until 70. Assuming a “full retirement age” of 66, a $1,000 monthly payment at that age becomes $1,320 at 70 if the recipient waits until that age to begin drawing it.
Uncle Sam’s 30 percent waiting bonus is in addition to any money you contributed to your other retirement plans and savings during those eight years of delayed payments, assuming you didn’t make withdrawals and were working or contributing to your savings. And keep in mind, there’s also the persistent power of compounding, which will multiply your nest egg, depending on how you invested and rate of return.
What if you chose to work past 62 and then collect Social Security at 70? In addition to the boost in Social Security benefits, your 401(k) could grow significantly in those eight years, even with conservative assumptions. Let’s say you had a $250,000 balance in your 401(k) at age 62 and decided to stay in the plan by contributing 10 percent annually with a 50 percent employer match (up to 6 percent). At a modest 5 percent rate of return, based on an $80,000 salary and 3 percent annual raises, you’d have nearly $482,000 at age 70.
But things get more complicated if you have a spouse and you choose to work longer.
There are some tricky rules regarding how spousal and survivor benefits are paid, so it would be worthwhile to talk to a qualified financial adviser or the Social Security Administration to see how to reap the maximum benefit. The simple math here is that higher-earning spouses should wait as long as they can before taking Social Security. The higher his or her preretirement income, the higher the spousal or survivor’s benefit. Conversely, it’s less of an advantage for the lower-earning spouse to delay since benefits are tied to lifetime earnings.
For same-sex couples, the process would work the same, but with one wrinkle: Couples have to be legally married and live in states that recognize the union. All of the other eligibility rules apply.
Another strategy is that the higher-income spouse can file for benefits, then ask the Social Security Administration to suspend payments. Then, the lower-earning spouse files for a “spousal” benefit — half that of the higher earner. This produces some cash flow until the top earner files for the maximum payment at age 70 and the other spouse can file for his or her regular benefit, which would also be a higher payment. It’s an interim strategy that might work for those who want to work longer or semi-retire.
“Focus on the full lifetime benefit for both spouses and delay until 70,” said Marty Allenbaugh, a certified financial planner for the mutual fund firm T. Rowe Price. “Protecting a survivor’s benefits is really important.”
Howard Hook, a C.P.A. and financial planner in Princeton, N.J., says you need to consider a wide range of health, income and tax issues before making a decision. While it’s tempting to take early benefits because of ill health, many underestimate their longevity.
“It comes down to your needs, not your health,” Mr. Hook advises. “Who’s working? Who has a pension? What kinds of savings do you have? If they don’t need the money now, I’m likely to tell clients to defer taking Social Security.”
Yet another approach — if you don’t mind locking in a lower payment — is to take Social Security at age 62 and let your nest egg grow as long as possible before withdrawing funds. That’s assuming Social Security and other savings, if available, could cover your daily living expenses. To make that determination, you would need to prepare a cash-flow analysis showing how much you and your partner or spouse need to cover your weekly expenses, then run a calculation showing how your savings could grow under certain assumptions like rate of return, additional contributions and employer match. You could work with a financial planner on this or use any number of free calculators on the Internet. Be sure to evaluate tax considerations and the effect on future payments to survivors.
Although Social Security math gets gnarly when two people are involved, there are a number of calculators that can help you reach a decision. The Social Security Administration provides simple tools to help you calculate retirement age, longevity estimates and benefits. T. Rowe Price has a free tool that can work with Social Security’s numbers.
For a more sophisticated analysis, consider the Maximize My Social Security software, written by Laurence J. Kotlikoff, an economics professor at Boston University. It costs $40 a year.
Keep in mind that Social Security can be a small but integral part of a complex puzzle of pensions, annuities, savings and other sources of income. A certified financial planner, certified public accountant or chartered financial analyst can review possibilities that take into account all of your assets and your tax situation.
The best decision allows you to maximize income, build your nest egg and not worry about running out of money.
I hope this helps!
Finally on a personal note, I’ve spent the last several days entertaining my daughter and 16 of her college friends who dropped in to enjoy some R&R, Halbert-style, on beautiful Lake Travis where we live. It has been a while since we entertained that many for several days, and my cooking skills were definitely put to the test! While we enjoyed entertaining them, Debi and I were not exactly sad when they left.
Very best regards,
Gary D. Halbert
Forecasts & Trends E-Letter is published by ProFutures, Inc. Gary D. Halbert is the president and CEO of ProFutures, Inc. and is the editor of this publication. Information contained herein is taken from sources believed to be reliable but cannot be guaranteed as to its accuracy. Opinions and recommendations herein generally reflect the judgement of Gary D. Halbert (or another named author) and may change at any time without written notice. Market opinions contained herein are intended as general observations and are not intended as specific investment advice. Readers are urged to check with their investment counselors before making any investment decisions. This electronic newsletter does not constitute an offer of sale of any securities. Gary D. Halbert, ProFutures, Inc., and its affiliated companies, its officers, directors and/or employees may or may not have investments in markets or programs mentioned herein. Past results are not necessarily indicative of future results. Reprinting for family or friends is allowed with proper credit. However, republishing (written or electronically) in its entirety or through the use of extensive quotes is prohibited without prior written consent.