By Gary Brooks, CFP®
Every month, more than 250,000 Americans turns 65. The Baby Boom retirement wave is now in full force.
Many of them, following rule of thumb planning may be unintentionally taking a path that could lead them to financial shortfall.
It is probable that bond returns over the next 30 years will be substantially less than bond returns over the past 30 years. Given changes in the direction of interest rates and current yields at historical lows, bonds face a strong headwind to generate much return – even in a nominal, non-inflation-adjusted sense. After inflation, returns for some types of bonds may be net negative. This will depend on interest rate changes and inflation growth.
There is precedent for this sort of long-lasting bond malaise. As we commonly hear about investment markets, history may not repeat itself, but it does rhyme.
Ibbotson’s Stocks Bonds Bills and Inflation Yearbook reports a substantial amount of data on investment returns over the past century. It’s not a new piece of information in the updated Yearbook that is cause for concern. The same numbers have been in the same data table for a long time. But the need to shine some light on the problem seems to be growing.
The table below presents investment returns by decade for several types of core investment assets in relation to inflation for each decade. Worth highlighting, and called out in yellow in the table, is a three-decade stretch of dismal returns for U.S. bonds. A simple 30-year average annual return for an equally-weighted mix of these bonds was just 1.89%. They failed to keep up with inflation for an entire generation.
The Barclays Aggregate Bond Index is the most-cited benchmark for the U.S. bond market over the past several decades. From its 1976 inception through 2013, it returned about 8% per year. Now, multiple investment researchers, forecasting interest rates, inflation and other bond market factors generally predict weak forward returns. So what is the newly 65 Baby Boomer to do when preparing to live 30 more years during a potentially low-return environment for assets that have historically been critical for retirement income? Here are 10 ideas that should be considered along with an understanding that bonds play an important risk management role in balanced investment strategies, even if their returns are underwhelming:
- Gain clarity about the amount of money you will need from investments to supplement Social Security, pension or any other form of retirement income. A retirement income plan helps you establish expectations and guides you when to adjust along the way.
- Understand how your needed income may be impacted by inflation over time so that you make decisions with the 30th year of retirement in mind just as much as with the first several years top of mind.
- Realize how your spending is likely to change (read more about U-shaped spending here). Instead of planning for a consistent income need throughout retirement, consider five or 10-year phases.
- Get used to the idea of taking withdrawals from principal in addition to income from interest and dividends. This is especially true if your portfolio needs to be rebalanced to adapt to changing market conditions. You can sell to rebalance and create needed cash at the same time, reducing unintentional overweights that naturally arise in your portfolio.
- On the topic of rebalancing: think globally. You may find better income with less risk by adding international stocks and bonds to your investment mix. Also consider other types of assets that aren’t commonly emphasized today such as convertible bonds or real estate investment trusts.
- Realize that returns for stocks during the low bond return generation (1940s-60s) were very good. It’s no certainty to continue this way. In fact, the probability of achieving historical stock returns is also lessening according to market researchers but stocks should still be expected to do more heavy lifting.
- New research even suggests that turning up stock market weight later in life optimizes probability of not running out of money. The most critical years to avoid risk of declines are the first few of retirement, not the last few.
- Become more comfortable with fluctuations in stock returns. Invest more in stocks than rules of thumb indicate you should. Stocks certainly have a riskier downside profile but as long as the money you’ll need to fund the next few years of retirement income aren’t exposed to stocks, your overall portfolio should benefit from their inclusion over time.
- Wait until interest rates have risen before locking in any annuitized forms of ongoing income. One indicator of better outcomes would be to wait for interest rates to exceed the long-term inflation rate of 3%, and perhaps only incrementally moving into these types of assets, adding more as interest rates rise.
- Consider downsizing your home to capture equity that can be another resource to supplement Social Security. If you’re set on staying in your home forever, a reverse mortgage may be a lifeline.
- Consider adding inflation-protected bonds to your investment mix to at least neutralize inflation. You can buy $10,000 worth of Class I U.S. Savings Bonds per person per year with no costs through Treasury Direct.
~ Brooks, Hughes & Jones Wealth Advisors – Gig Harbor, WA – www.BHJadvisors.com