How Rising Interest Rates Help Retirees

The 10-year US treasury is bouncing around 3%. Retirees should view this as good news because it means they will likely receive more interest income from bonds over their retirement if rates hold. Even factoring in the decrease in value of bonds, the rise in interest rates will more than make up for the decline in bond value over the long-term assuming rates hold.

Let’s view a simple example. At the beginning of 2021, treasury bonds maturing in 10 years were paying 0.93% annually in interest. As of May 13th, 2022, 10-year treasury bonds are paying 2.93% interest. Let’s assume we have two retirees with almost identical situations, Bill and Jennifer. They both retire at age 65, and they both have 30-year retirements. The only difference is Bill receives 0.93% interest on his bonds, while Jennifer receives 2.93%. They each keep $500,000 in bonds and live off the interest. Rising rates led Jennifer to receive $300,000 more in interest payments over her lifetime! See the chart below for a summary of this example.

Bond interest rate during retirement0.93%2.93%
Starting bond value$500,000$500,000
Annual interest income$4,650$14,650
Total interest income over 30 years$139,500$439,500

One factor missed in this simple analysis is how bond prices react to interest rates. Bond prices and interest rates generally go in opposite directions. When interest rates rise, bond prices generally fall, and vice versa. At the beginning of May 2022, the Bloomberg US Aggregate Bond Index, one of the most followed US bond indices, is down over 9% year to date (because interest rates have risen). However, for retirees with a long timeframe, the expected increased interest payments will be much larger than the decline in value assuming rates hold. Let’s include this factor into our example above. Due to rising interest rates, Jennifer’s bonds now are only worth $450,000, while Bill’s bonds are still worth $500,000.

Bond interest rate during retirement0.93%2.93%
Starting bond value$500,000$450,000
Annual interest income$4,650$13,185
Total interest income over 30 years$139,500$395,550
Interest income + starting bond value$639,500$845,550

Jennifer still receives over $200,000 more in income than Bill during their retirements.

While these examples leave out a lot of complicating factors, they illustrate the main idea that rising interest rates are generally “short-term pain, but long-term gain” for long-term investors.

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