When would you like to retire? The answer probably depends upon your age. If you are in your 20s (and unless you love your job), you may well think that working past 40 is for losers. You will come up with some brilliant business idea that makes a fortune, inherit a tidy sum or marry someone rich.
Maybe you don’t even think about retiring at all. By the time you reach your 30s, however, the grim truth dawns on most of us. Somehow you never did turn into the next Bill Gates and that rich Aunt remarried a toy boy and left all her money to him. Meanwhile, that well-off boyfriend/girlfriend you were hoping to snare preferred someone who also had a Ferrari. You always knew the rich were superficial!
By the time you hit your 40s, the distant hills of old age no longer seem too far off. You really want to retire much earlier than in your late 60s, when your state and occupational pensions will start to pay out. They may have even raised the retirement age to 70 by the time you get old! You and your partner want to see how much you will need to save to generate an income that will allow you to pack in work early.
You sit down one evening and decide that €30,000 between the two of you should just about do it. By the time you are 55, you will have paid off the mortgage, the children will have left home and it will be time to enjoy yourself. So, you go to see a financial adviser to look at investment options.
This proves a bit of a shock. It turns out that you will need to have three million in US treasury bonds, effectively IOUs issued by the US government, that currently pay a yield of around 0.9%, or around €900 per annum, to earn an income of €30,000!
Higher risk leads to higher rewards
However, the financial adviser explains that US treasury bonds, which are backed by the US government, are considered to be the safest investment on the planet and there are plenty of other homes for your money that pay a higher return.
So how about equities? The adviser cites one of the largest European equity income funds, which will give you a 2.5% dividend yield. That is much higher than the income generated by treasuries but still means you will need to have saved well over a million euros to generate that €30,000! Like many another person, and particularly after the setbacks suffered by financial markets in the wake of the covid-19 crisis, you may well decide to ditch any early retirement plans.
But why are returns so low? After all, as the chart below shows, it wasn’t always this way. Back in the 1980s, you could save into retirement plans that offered you a guaranteed 10% pension income. Moreover, if you had bought treasuries at the beginning of that decade, you could have got a 15% yield, so €200,000 would have got you that €30,000 of income. What has gone wrong and why do you have to save such astronomical sums now to retire comfortably?
Well, one of the reasons interest rates were so high back in the 1980s was that inflation was also much greater than it is today. Governments hiked borrowing costs to stamp down on inflation. That measure, along with the explosion of cheaply-manufactured goods from China, brought down inflation, so borrowing costs and savings rates also tumbled.
In addition, after the global financial crisis of 2008, the authorities embarked on a huge spree of Quantitative Easing, effectively printing money to buy up bonds and even equities to support financial markets and the economy. That proved very effective and stock and bond markets have soared over the past decade. Bond yields move in the opposite direction to bond prices so as bond prices have leapt, yields have slumped. Financial markets, which fell sharply following the Covid-19 outbreak earlier this year, have recovered strongly as central banks once more turn to the magic effect of QE.
Indeed, some boffins at Société Générale have now estimated that without QE, the yield on the US 10-year treasury bond would be 1.8 percentage points higher than it is today. In other words, investors would be getting an almost 3% return.
Moreover, don’t forget treasuries are considered to be the safest investment in the world. Every other investment is priced off them so if treasury yields stood at 3%, yields on corporate bonds and equities would probably range between 5-6% today.
By the way, the Nasdaq-100 (a stock index measuring the performance of technology shares in the US) would have been closer to 5,000 than 11,000 (at the end of October 2020), while the S&P 500 (an index of leading US share prices) should be nearer 1,800 rather than 3,300. So basically, share prices are also most double the levels they would otherwise be without QE. That is also pretty worrying.
Of course, interest rates may move higher in the coming decades but I wouldn’t bank on it. Many economists believe interest rates will remain at these very low rates for many years to come, perhaps even decades, if only because governments need to keep borrowing costs low so that they can service their debts and keep the electorate happy by maintaining spending on health, etc. Of course, the big financial institutions realise this and are moving into alternative assets such as private equity, where they invest in companies directly rather than those listed on the stock exchange, and infrastructure. Sadly, that is not an option for individuals. So, it is a depressing thought but retirement may already be a luxury for the rich only.
By Anthony Beachey
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Anthony Beachey is a former BBC World Service journalist now working on a freelance basis in Portugal, where he specialises in economics and finance.
