As interest rates rise, retirees cheer

Many investors would benefit from another Fed rate hike Wednesday.

When banks offered to pay 1 to 2 percent interest for a certificate of deposit two years ago, Charles Van Stone felt insulted, even angry.

But now, after the Federal Reserve has hiked interest rates 15 consecutive times, the retiree recently found a Virginia bank that would pay him more than 5 percent. "It gives me some dignity," says the Shepherdstown, W.Va., former government employee.

Wednesday, when the Federal Reserve is expected to raise interest rates for the 16th consecutive time, at least one group will be cheering: retirees like Mr. Van Stone and other conservative investors. They remember the 1990s, when some CDs paid as much as 7 percent, and they're ready to leave behind the rates of two years ago, when many had to eat into their principal to meet expenses. Now, for the nation's 35 million seniors - many with some type of investments - the interest rates on their CDs and savings accounts are much better as the nation's mentality begins a subtle shift from consumption to savings.

"For most of our members, rising interest rates are a good thing," says Clare Hushbeck, an economist at AARP. "Aside from earning more interest on their savings, they are finished making interest-sensitive purchases such as automobiles or houses."

Still, recent economic data have sent mixed signals. On Friday, the Labor Department reported the economy created 138,000 jobs in April, well below the prior months, when it was producing 200,000 jobs or more. Economists aren't certain if the lower jobs number means the economy is finally slowing down or if it's a temporary phenomenon. Wall Street interpreted the numbers as indicating the Fed might be finished raising interest rates, and stock prices roared on Friday, with the Dow Jones Industrial Average climbing 138.88 points. Monday morning, the rally continued, but in a more modest fashion.

A stock market rally can be good for many kinds of investors - including retirees. According to the 2004 Federal Reserve Survey of Consumer Finances, 46 percent of heads of household who are ages 65 to 74 hold stock either directly or indirectly, such as through mutual funds. And 35 percent age 75 or older own stock directly or indirectly.

But for the most part, retirees are more conservative with their investments. "Most seniors are interested in minimizing risk versus maximizing their returns," says Tim Smith, a certified public accountant in Queensbury, N.Y.

For example, when CDs were paying only 2 percent, an individual with $500,000 in assets would have received approximately $10,000 in income. Now that rates have doubled, an individual's income would double as well to $20,000.

However, retirees and their advisers are quick to point out that seniors, like everyone else, are experiencing higher costs on everything from gasoline to prescriptions. "When you are on a fixed income, that hits you harder," says Elmer Gooding, a retiree in Tempe, Ariz. "Rising energy prices permeate the whole economy."

Rising medical expenses can also quickly eat into a savings account. "Medical inflation is running at two to three times the general rate of inflation," says Ms. Hushbeck.

The combination of rising gasoline prices and flat incomes may be one reason that seniors are more pessimistic than the general population in consumer confidence surveys. This is not a surprise to Chris McCarty, director of the University of Florida's consumer confidence surveys.

"Increasingly, seniors and others in Florida are living day to day, and some are probably incurring credit-card debt to survive," says Mr. McCarty. "They just don't have enough money to live on, and their only asset is their home."

Ed Slonaker, a certified financial planner in Martinsburg, W.Va., says one client, a retired schoolteacher, used 100 percent of the income from her CDs, plus all her pension, for living expenses. "When she got unexpected bills, it was eating away her principal," he says. "She was scared to see how much her purchasing power was eroded."

Even with interest rates for CDs on the rise, seniors and conservative investors have to look hard for the best rates. For example, Van Stone found that the two banks in his community were offering only 3.5 to 3.6 percent. Like many retirees, he didn't feel comfortable sending money to a financial entity advertising on the Internet, where interest rates are often higher. Instead, he found a small bank in Virginia offering a 5.1 percent rate for a six-month CD.

The wide difference in rates is not surprising to Herbert Kaufman, former chairman of the finance department at the W.P. Carey School of Business at Arizona State University. "Obviously, the West Virginia banks didn't feel like they could loan out the money at a sufficiently profitable spread, and the Virginia bank did," he says. "But I think in general banks are more aggressive than they had been."