I witnessed a something telling when I was in Nicaragua this year just before the pandemic started. If you read this blog regularly, you may know that I often visit the resort town of San Juan del Sur on the Pacific coast of Nicaragua, not far from the border with Costa Rica. While in a shop in the town buying water, I came across an elderly American that was arguing with the cashier about buying a few small items. All of the sudden he left in a huff, flustered he didn’t get his way.
When I came up to the register next and asked the cashier what his issue was, she said he wanted to buy some beer with the 20 cordobas he had left but it wasn’t enough to buy the beer he wanted. He asked if the cashier would accept colons (the currency of Costa Rica) and when she refused, he left without purchasing anything. 20 córdobas is about 60 US cents so I asked why she thinks he would make a scene about this amount of money, especially considering that he was American and looked to be retired. She explained that more Americans had been coming over to spend time in Nicaragua from Costa Rica lately due to the lower cost of living on the Nicaraguan side but they always try and spend all of their cordobas before they leave. Her refusal blocked this man’s attempt to rid himself of his cordobas before going back home to Costa Rica.
Low Rates and Retirement
I thought of this reaction recently when I came across a few articles and blog posts which discussed how the traditional investment advice of bonds and stocks is being upended by the low interest rate environment in much of the rich world. When it comes to bonds, how much you need to retire and live off sustainable income is highly dependent on interest rates.
Let’s take a simple example to understand why. Let’s say a retiree wants $40,000 to live off of in retirement in addition to their social security. We assume this is coming from private savings and they don’t have an additional pension. Let’s also assume this retiree is very conservative and would like their retirement income to be from bond interest only, with a portion of their portfolio in stocks which will grow faster than inflation just to maintain the purchasing value of their bond portfolio.
When bonds yield 4%, the math is easy: save $1 million and you can live off of $40,000 per year in interest. Throw in some stocks, which grow faster than inflation, say $250,000 additional, as part of your portfolio and you will have an easy recipe for a comfortable retirement. This has made the job of financial advisors for middle class people relatively easy for the latter half of the 20th century. In the 21st century however, with rates at or below zero in many of the major economies, that $1.25 million that may have been needed before when rates are at 4% becomes $2.5 million when rates are at 2% or $3.5 million when at 1.4% which is what the 30 year treasury bond is hovering around currently.
This has created a quandary for retirees. To make the same income in retirement and take the same risk as when rates were 4%, a saver would have to accumulate almost triple the amount of money for retirement. This leaves them with a few difficult choices. They can either save more, reducing their quality of life now to be able to enjoy it later, take more risk by investing a larger part of their portfolio in stocks or they can make an active decision to reduce their expenditures in retirement. Many people it seems, including our American friend in that shop, are choosing to do the latter.
Inequality Arbitrage
What do you do to maintain your lifestyle on less money? For most people the answer is to move somewhere cheaper. I like to call this inequality arbitrage. Taking advantage of a lower cost of living in one place with your savings accumulated in a wealthier place. Many retirees in the US already practice this by moving to a state or town which is cheaper to retire in. Florida versus New York, Arizona versus California or even just small town versus larger city.
What do you do when you don’t have enough saved though and you need to reduce your expenditures in retirement even more? Well you may just have to do that same inequality arbitrage but in a more extreme manor: move out of the country all together to a cheaper country.
This has been common for many years but is still only a small minority of retirees in the US. Americans have been choosing to retire in Mexico for decades as it offers good weather in combination with low costs. As with all markets though, higher demand raises prices and retiring in Mexico in a community with other Americans may not offer the fantastic deal it once did, so some look to other low cost countries.
One of these places, especially in the early to mid 2000’s was Costa Rica. It had all the hallmarks of a retirement Mecca for Americans: low cost of living, good weather and a short flight time back to the US. Once again though, as the secret got out, Costa Rica became more expensive for retirees, which brings us back to the man in the shop in Nicaragua.
When you think about this all this in that context, it starts to make sense why that man was arguing about 60 cents. Every penny probably had to count for this man. Limited savings, limited opportunities for additional income and higher costs of living in his once cheap retirement destination likely pushed him over the border to enjoy a respite, once there though, he had to make every dollar count.
In fact, I noticed that many had made the jump to living full time in Nicaragua already. The restaurants and bars of San Juan de Sur have a consistent stream of American retirees who have permanently planted themselves in the town. Although this community is relatively small, it is telling of the consequences of not just not saving but also of the low interest rate environment retirees find themselves in today.
A Foreign Exodus
Many people are very hesitant to live in a foreign country, especially when they haven’t ventured much outside of their own. As the potential cost of a stable retirement income becomes so great however, could we see more of this happen, especially for working class people from rich countries who dream of retiring some day?
The barriers to entry are significant: a different language, different laws, food, customs and social norms. This keeps many people from making the leap. Just as immigrants in the early half of the 20th century overcame these hardships for a better life, you have to wonder if the bleak situation for working people and saving in much of the rich world could be forcing many people to go the opposite way?
This isn’t a problem for the relatively wealthy. Mean household income for the top 20% of earners has been increasing again since the crisis after a long lull and hangover post the dot com boom of the late 90’s.
Source: Advisor Perspectives
Earnings for the rest of the population however have been flat for over 50 years. For this portion of the population, low interest rates are nothing but a curse: they produce predatory lending which takes advantage of those that can least afford to be swindled and it robs them of safe supplementary retirement income.
For some, the only option left is to take more risk by tilting their portfolios more towards equities and risky assets. Some have speculated this may have been a factor towards pushing equity valuations up, especially after the pandemic induced drop in rates experienced in March. There are also those that argue that tilting bond portfolio assets towards longer maturities may also be the answer. Loading up on 30 year bonds makes the bond portfolio increasingly sensitive to small changes in interest rates and if rates are to fall even more, perhaps even go negative, then there is room for a decent upside.
However, the example of the effect of negative rates on the EU as well as Japan has rightly given the Fed pause and pushed them to commit to zero rates with alternative measures in place as opposed to an actual tax on savings, which is what negative rates essentially are. Where you may see the dynamic start to change it increasing the tenor of government bond issuances to offer higher spreads (and more volatility). Currently the benchmark is 30 years in most advanced economies with some issuing up to 100 years. These “century” bonds are still more of a curiosity and snapped up by insurance companies worried more about hedging, but when governments see they can issue tenors this long at attractive rates, what is to stop them from stretching out repayment even further if investors are willing to fund it?
Low rates and alternative quantitative easing seem to be with us for the foreseeable future. The question facing retirees is how far this will push them towards extremes such as deciding to retire abroad due to cost? Those who have already taken the leap have voted with their feet on what the future for many in the middle and working class will hold.
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