The classic retiree portfolio mix of low-risk, fixed-income products that return reliable income is all but over — especially in the era of low interest rates.
And now, with the Federal Reserve signaling that interest rates will remain low for a very long time, retirees will have to consider a different portfolio mix if they want their retirement holdings to keep up with inflation and produce income.
“I don’t think there’s any doubt that we would expect fixed income portfolios to have less than historical returns given where rates are at and where they’re potentially to go in the future,” says Matt Schwartz, certified financial planner at Great Waters Financial.
Since 1928, U.S. Treasury bonds have averaged a 5.15% annualized return, while medium-quality corporate bonds have returned 7.22%. Adjusting for inflation, real returns for that time period were 2.17% for Treasurys and 4.22% for corporate bonds, says Amy Arnott, portfolio strategist at Morningstar. She agrees that bond yields are highly unlikely to reach the same return levels over the next 10 years.
There are a few options for retirees to build a retirement portfolio, financial experts say. That said, they all come with trade-offs — usually in the form of higher risk. Here are a few things to keep in mind when you shake up your retirement portfolio mix:
— Save more and increase equity holdings.
— The role of bonds now.
— The bucket and barbell approaches.
Save More and Increase Equity Holdings
If you have a few years before retirement and possess the means, Arnott says increasing your savings rate while reducing spending in retirement can go a long way toward offsetting lower returns. Of course, that may not be feasible for every pre-retiree and retiree.
“If you’re still finding a shortfall, I think it is worth considering whether you need to tweak your asset allocation more toward the equity side,” she says.
Because of the inherent volatility and potential losses during market downturns, Arnott cautions retirees to increase that allocation marginally — by about 5%, depending on your risk tolerance.
Arnott adds that pre-retirees may want a mix of around 70% stocks and 30% bonds, while those in retirement may want something like 65%-35% as a way to add a little bit of growth to offset the reduction in fixed-income yields without taking on too much risk.
Aside from the volatility, equities are expensive again following the market’s rebound after the first quarter’s market sell-off, says Paul de Sousa, senior vice president and investment advisor at Sightline Wealth Management. Investors are moving into equities on the idea that there isn’t an alternative with interest rates so low.
De Sousa says his firm is using private investments as another way to offer retirees higher returns with low correlations to the stock market. However, these types of investments are usually only available to people who use financial advisors.
Alon Ozer, chief investment officer at Omnia Family Wealth, says building a safe, stable portfolio isn’t easy for retirees in the current environment, especially for those who prefer investing for themselves rather than using an advisor. “They have two options right now, which is basically to take on additional risks, or compromise and get a lower return,” he says.
Self-directed investors can use a mix of equities and corporate bonds to boost yields, he says, but he advises them to stay away from some of the new investing strategies such as liquid alternatives that issuers say replicate the alternative strategies popular with institutional clients like hedge funds. Ozer says he believes they do not perform that well.
Instead, for smaller investors, he likes the Cambria Tail Risk ETF (ticker: TAIL), an actively managed fund holding mostly cash and U.S. Treasurys while buying S&P 500 put options as a downside buffer.
The Role of Bonds Now
Arnott says with the 10-year U.S. Treasury yield of around 0.6%, these ultra-safe investment vehicles are barely keeping up with inflation.
Experts say bonds still have a part in retiree portfolios, although it’s not in their traditional role as income providers. Rather, they can act as a ballast in market downturns, and Schwartz notes that, with a few exceptions, bond portfolios were flat to slightly higher when the stock market fell more than 30% in the first quarter.
“They still provide that diversification, especially for the short term, or for the retiree who’s worried about the short-term expenses that they might have,” he says.
Arnott says there are some areas of the bond market with slightly higher yields without excessive risks, such as a short-term municipal bond fund for retirees in higher tax brackets or intermediate core bond funds. Two examples of these types of funds include the Baird Short-Term Municipal Bond Fund (BTMIX), a mutual fund, and the iShares CMBS ETF ( CMBS).
The Bucket and Barbell Approaches
Arnott says it still makes sense for retirees to use a bucket approach to build their portfolios, which entails dedicating your money into thirds: among short-term, medium-term and long-term investments. The short-term bucket holds enough cash and cash-like equivalents so that retirees can meet their expenses for at least one to two years, while the medium- and long-term buckets can take on more risk for greater growth. She says retirees who plan to boost their equity holdings may do so in the medium bucket, which holds money with a three-to-five-year time horizon.
Schwartz says his firm will use a barbell approach, increasing the amount of cash and other liquid investments to cover three to four years of expenses and then devoting the rest of the portfolio to holdings designed to grow. How the portfolio is divided depends on the retiree’s income needs.
The long-term part of the portfolio — investments with a time horizon of five years or more — could hold a mix of domestic and international equities, for example.
He says the short-term part of the portfolio can be a mix of asset classes, including cash, fixed indexed annuities and laddered government bond portfolios. “You want to have a mix of conservative investments that a person can live on to cover an extended recession, like in 2008,” he says.
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