Solving for the Major Risks in Retirement
Bond yields have fallen steadily, more or less, for the past 30-plus years—from nearly 16% in the early 1980s to under 2% during the past year1.
That has helped create a booming bull run for fixed-income securities during this roughly three-decade period, since bond prices move inversely to bond yields.
But the bond party may be winding down. Bonds are finally starting to lose some steam in the wake of an improving economy, less accommodative monetary policy by the Fed, and rising interest rates. In fact, during the fourth quarter of 2016, the Bloomberg Barclays US Aggregate Bond Index was down nearly 3%—its’ worst quarterly return since the third quarter of 1981.
That could spell trouble for some more common and popular retirement income strategies.
Take target-date strategies, for instance. Target-date strategies that systematically decrease equity allocations as retirement approaches have become extremely popular, due to the attractive appreciation in aggregate bond prices over the past 30-plus years and due to the smaller drawdowns of fixed-income portfolios compared to equity portfolios.
While this type of investment strategy may have worked well over last three decades, we believe there may be risk in retirement portfolios that are heavily weighted towards fixed-income securities in the years to come.
Let’s review some our most salient points about these major risks in retirement.
4 Major Retirement Risks
Retirees must confront and address four key risks that potentially threaten their financial security:
1. Inflation – In our blog on inflation risks, we highlighted the reality that inflation may erode the real purchasing power of today’s dollar over a 20-plus-year retirement horizon. Additionally, we highlighted the rising costs of various components of a typical retiree’s budget. Example: With healthcare costs expected to grow by as much as 6.5% per year, the future costs of healthcare could be 3.5 times today’s cost after 20 years–and 6.6 times today’s cost after 30 years. The reality is that bond returns are not likely to keep up with that kind of cost inflation.
2. Interest Rates – In our blog on interest rates, we examined how stocks and bonds have behaved historically during different central bank policy regimes. In years when the Fed’s target fund rate has gone up, bonds have significantly underperformed stocks. Remember that the Fed raised rates in December. Going forward, rate hikes may be more likely than not in 2017.
3. Longevity – In our blog on longevity of spending, we showed how investments in growth-oriented assets can help stretch your dollars. According to our analysis, a 6% annual return could double an investor’s expected spending years in retirement compared to keeping savings in cash. Additionally, over long horizons, bad sequences of returns for stocks still outpaced good sequences of returns for bonds.
4. Liquidity – In our blog on liquidity risk, we studied the severity of a poor sequence of returns for various portfolios by measuring how long hypothetical portfolios were “underwater” during crisis times. Our analysis shows that even during the worst market crashes of the last fifty years, even 100% equity portfolios recovered rather quickly. By keeping enough liquid assets to cover spending needs for a few years, equity-focused investors could have weathered even the worst markets of the last fifty years.
Learn more now about Real Spend®, our retirement income solution designed to be flexible for the uncertainties of life.
1U.S. Intermediate-Term Government Bonds.