For all but the wealthiest of investors, there are few things more terrifying than retiring and then experiencing a sudden stock market downturn that puts a huge dent in your hard-earned nest egg.
Even if a bumpy market in the short term averages out to produce positive returns over the longer term, just a few ill-timed rocky years at the beginning of retirement can lead to a permanent shortfall for retirees. Experts call this phenomenon “sequence of returns risk,” and the danger is real.
In a study conducted shortly after the 2008 financial crisis, Pew Research Center found 35 percent of working adults age 62 and older said they had delayed retirement because of the recession.
[See: 7 Things That Can Derail Your Retirement Investing.]
Fast-forward to 2018, and although there are no signs of a deep recession around the corner, recent stock market volatility is rattling some investors. Allianz Life’s 2018 Market Perceptions Study, released last week, shows 37 percent of Americans admit volatility is making them anxious about their nest egg and 38 percent said that if the market experienced a significant drop, there is no way they could rebuild their savings in time for retirement.
It’s hard even for Wall Street experts to predict the market’s next boom or bust, so what’s the average Joe to do to mitigate the risks?
Consider the bond tent.
“Much like the need for a tent when camping, investors nearing retirement age need shelter to protect them from undesirable forces in the markets,” says Charlie Ripley, senior investment strategist for Allianz Investment Management.
With a bond tent, an investor gradually allocates a larger portion of his or her portfolio to bonds as he or she nears retirement. As an example, a 55-year-old who is gearing up for retirement, might slowly transition his portfolio of 60 percent stocks and 40 percent bonds, to just the opposite — a 40/60 ratio of stocks-to-bonds over a 10-year period. Then, once he retires at 65, he starts utilizing the bonds to fund the early years of retirement. Eventually, as he spends down those bonds, the portfolio reverts back to its original 60/40 stocks-to-bonds allocation.
The aim is to reduce volatility and protect the portfolio against large declines in the equity market in the initial years of retirement.
“As a result, the allocation to bonds in the portfolio increases to peak at retirement age and slowly tapers off during the golden years of life,” Ripley says. “The allocation to fixed income relative to equity is shaped like a tent over the retirement age, hence the strategy is often referred to as a bond tent.”
A bond tent can be an appropriate tool for investors who will not have large Social Security payments or pensions, and who will need to rely primarily on income from their portfolio to fund retirement, says Matt Chancey, a financial advisor affiliated with the Claraphi Advisory Network.
[See: 11 Steps to Make a Million With Your 401(k).]
Of course, as with any investment, there are some risks. As the Federal Reserve raises interest rates over the next few years, investors going into this strategy should understand that bonds may not perform as well as they have in the past.
“Bonds may not be as much of a safe haven today as they have been, and that’s really the risk when considering a bond tent,” Chancey says.
Even so, bear markets for bonds tend to be far less severe than bear markets for equities, and advisors still recommend high-quality bonds to conservative, risk-averse investors. Vanguard notes that even the worst 12-month period for the U.S. bond market resulted in just one-fifth the losses of the worst 12-month period for the U.S. equity market.
“The reality is that we cannot predict when a downturn will actually happen and what its magnitude will be. Hence strategies like bond tents are critical to the financial well-being of retirees and near retirees.” says Chris Chen, a financial planner for Insight Financial Strategists in Waltham, Massachusetts.
“However, the key is to start with financial planning in order to understand the actual amounts that would be needed. In this way clients can make sure that their portfolios are not overly conservative.”
In Chen’s opinion, all retirees should use a similar system.
[See: 7 Monthly Dividend Stocks for Steady Income.]
“Possibly folks who have more resources than they plan to use in their retirement years can do it differently,” he says. “However, those people are actually few and far between.”
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How a Bond Tent Protects Your Nest Egg originally appeared on usnews.com
