What do lower interest rates mean for your pension?
Navigating the intricate landscape of retirement savings can be daunting, especially with ever-fluctuating interest rates that directly impact pension outcomes. Could investing in multi asset funds be the solution?
As interest rates rise and fall, the value of pension funds can experience volatility. However, investing in a multi-asset fund can present a robust solution for retirement planning, offering a diversified approach that insulates investments across all areas of the market cycle.
At Zurich, we recognise the importance of adaptability in managing your retirement savings. By actively managing our funds, our fund managers have the flexibility to make strategic decisions based on evolving market events, ensuring your pension remains resilient and well-positioned for growth amidst changing economic conditions.
Central Banks are now beginning to cut rates
In Autumn 2023, the European Central Bank (ECB) increased its benchmark deposit rate to 4% to address high inflation, marking the 10th consecutive hike since July 2022. The rate had risen from minus 0.5% to 4% in just over a year. In June 2024, the ECB made its first rate cut in nearly five years, reducing the deposit rate to 3.75%. At its September meeting, the ECB further lowered the deposit facility rate by 0.25% to 3.50% and followed this up with the third rate cut of the year in mid- October, with a quarter[1]point reduction bringing the rate on banks’ deposits to 3.25%.
Similarly, in the US, after a year of the Federal Funds Rate being in the 5.25% - 5.50% range, the Federal Reserve implemented its first interest rate cut since the early stages of the Covid pandemic, lowering the federal funds rate to a range of 4.75% - 5.00% in September.
Whilst the future remains uncertain, it is anticipated that both the ECB and the Federal Reserve will continue their rate-cutting cycles into 2025, although this will depend on the broader economic environment. These sharp moves, from negative rates in the eurozone just over two years ago, to an all-time ECB high, to the recent turn downwards affects us all in many ways – including our pension investment.
Impact on asset classes
Central banks’ decisions are reshaping the financial landscape, with lower interest rates typically stimulating economic growth and influencing consumer trends. In a lower interest rate environment, equities have traditionally benefitted. In the fixed income market, high-yield bonds may outperform as they attract investors seeking higher returns in a low-interest-rate setting. However, the journey to lower rates is as influential as the final rate that policymakers settle on.
In a low-interest-rate environment, consumers are more inclined to finance purchases such as homes and cars through borrowing. This increase in consumer demand boosts corporate sales, enhances manufacturing activity, and contributes to a positive economic cycle. For businesses, a lower rate environment reduces borrowing costs, improving debt profiles and encourages capital expenditure. Companies are more likely to increase borrowing for investments, further stimulating economic growth. Equity valuations also benefit from a lower rate environment.
The present value of future earnings is calculated using a discount rate, and lower interest rates reduce this discount rate. This reduction increases the present value of projected cash flows, thereby enhancing the theoretical value of shares, particularly for more ‘growth’ orientated companies.
Typically, as interest rates are cut, bond yields decrease because existing bonds, issued at a higher rate, become more valuable, therefore driving up their price. Once the lower interest rate environment settles, bond yields stabilise at lower levels. New bonds issued will offer lower yields, reflecting lower interest rates in the market, and the price will have increased on existing bonds, also reducing their yields. As a result, bonds overall become less attractive compared to other investment options.
To shield your pension from market fluctuations, multi-asset funds are advantageous in retirement as they provide protection throughout all phases of the market cycle. The Personalised Guide Path strategy from Zurich is based on our risk-targeted range of Prisma multi-asset funds, which diversify investments across multiple asset classes. This strategy is designed to perform well in all market conditions and at every stage of a client’s retirement savings journey.
What are your options at or nearing retirement?
Defined Contribution participants who are near or in retirement are likely to feel significant impact from changes in interest rates. High interest rates tend to benefit those seeking income, as they offer higher returns on savings. Since most retirees aim to eliminate debt and increase their savings, usually investing in lower-risk funds with less equity exposure, lowering interest rates can be unwelcome news for those nearing or in retirement. Lower interest rates reduce the returns on risk-free assets, potentially forcing conservative investors to face higher-than-normal risks due to inflation.
In a low-interest-rate environment, retirement investing becomes more challenging because the reduced rates weaken returns on safer investments such as bonds or money-market funds, which retirees often rely on for stable income. When interest rates fall, these traditionally low-risk assets yield minimal returns, making it harder to grow savings through conservative investments.
The guaranteed income from an annuity is likely to be lower in a low-rate environment, though annuities may still be suitable for risk-averse retirees who prioritise stable, predictable income, even if that income is lower than it would be in a high-rate period. Approved Retirement Funds (ARFs) offer more flexibility and potential for higher returns but come with the risks of market volatility and the possibility of depleting savings. In a low-interest-rate environment, the choice between an ARF and an annuity largely depends on an individual’s risk tolerance and retirement goals.
Need help deciding? Try our Annuity or ARF tool to explore your options or talk to one of our experts to find the best choice for your retirement needs.
The information contained herein is based on Zurich Life’s understanding of current Revenue practice as at November 2024 and may change in the future.
Warning: Past performance is not a reliable guide to future performance.
Warning: Benefits may be affected by changes in currency exchange rates.
Warning: The value of your investment may go down as well as up.
Warning: If you invest in these products you may lose some or all of the money you invest.
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