Here’s the Bad News About Long-Term Interest Rates

Federal Reserve Chair Janet Yellen Testifies Before The Joint Economic Committee
Photo by Bloomberg Bloomberg — Getty Images

Retirement savers have been waiting years for yields (that is, the interest rates on fixed-income investments) to revert back to historical norms. But they may need to wait even longer – as in, an eternity.

Some investing experts believe that long-term rates will readjust to levels well below historical averages because of global demographic shifts. Rather than hoping to find high-paying assets, investors may need to pursue a less desirable alternative: saving more.

Interest rates on ultra-safe investments like Treasury bonds have been hovering near record lows since the Great Recession. The Federal Reserve, under chair Janet Yellen, has signaled that it’s likely to raise rates as the economy improves, but only very gradually. There is a “mental model of what people think rates will go to, and for a lot of people it is 5%,” says Russ Koesterich, head of asset allocation for the Global Allocation team at investing giant BlackRock (BLK). “In a world with slower growth and where populations are older, 5% might not be the right level to anchor to.”

For more about interest rates, watch this Fortune video:


According to a 2011 paper by David Bloom at the National Bureau of Economic Research, the global population age 60 and over nearly quadrupled to 760 million in the fifty years leading up to 2010, and by 2050, it is projected to reach 2 billion. The number of octogenarians will rise from 14 million in 1950 to around 400 million by 2050. In the U.S., the median age will rise 5%, to 41 years, between 2000 and 2050, according to a 2012 BlackRock paper titled, “Not So Golden Years.”

An aging population can affect the economy in several ways. First, it lowers the labor participation rate—the share of adults participating in the workforce. That percentage peaked in the U.S. in 1998, and recently it hit its lowest levels since the 1980s, when women started to enter the work force in large numbers.

BlackRock says this decline in labor participation is partly responsible for a corresponding decline in economic growth, accounting for roughly a quarter of the variation in growth of GDP. When workforce participation was at its high in the late ‘90s, the U.S. was growing at an average rate of more than 4%. For the past 15 years, the average growth rate has been well below 2%. And slower growth often corresponds to lower interest rates.

“We can get a glimpse of what may be in store for the United States by looking at Japan, where in a somewhat frightening parallel, economic growth has averaged 0.9% annually over the past two decades, and just 0.7% in the 2001 to 2010 period,” BlackRock’s paper says, though Koesterich adds that U.S. demographics are considerably better than Japan’s.

Perhaps more important, as a population starts to retire, their investment needs change, and this has an effect on asset prices. As people reach retirement age, they shift their portfolios to bonds. The old rule of thumb used to be that retirement savers should subtract their age from 100 to determine the percentage of stocks they should own. (So a 70-year-old would have 30% of her portfolio in stocks.) While there’s growing evidence that today’s retirees may need to own more stocks than earlier generations did, the retirement of the large U.S. baby boomer cohort still means growing demand for bonds.

In addition to this secular shift in portfolios, a paper published by the Kansas City Fed predicts a gradual overall increase in bond ownership among people older than 65 compared to the same age group in previous years. In 2001, people over 65 had about a third of their portfolios invested in bonds. The Kansas City Fed predicts this share will rise to 43% by 2040.

This increase in bond ownership can push prices up, and further depress long-term yields, which fall as prices rise. Koesterich warns that, in a world where yield is already hard to find, generating retirement income may simply get harder. “Even if you have done everything right, the income that pool can generate is probably going to be less than [you] thought,” he says.

The answer? Save more. “For younger people 15 years away from retirement, it may take a larger pool of assets to generate that income.”

Blackrock offers a tool that it calls the CoRI retirement savings calculator, found here. This tool uses the present value of bond portfolios, adjusted for interest rate and inflation expectations, to show current retirees how much in retirement savings they need today to account for every $1 they need in the future, assuming they hold a portfolio made up entirely of investment-grade bonds and longer-term Treasurys. For example, a person aged 60 needs $19.44 today for every $1 they expect to spend annually during retirement.

Subscribe to Well Adjusted, our newsletter full of simple strategies to work smarter and live better, from the Fortune Well team. Sign up today.

Read More

CryptocurrencyInvestingBanksReal Estate