Retirees can no longer protect their future income stream using a "Buy-and-Hold" strategy, whether funds are invested primarily in equity (stock) investments or a combination of equity and fixed-income (bond) investments found in so-called “balanced” mutual funds or “balanced” bank trust accounts.
The reason is simple. Fixed-income securities will no longer provide the necessary returns to adequately buffer future serious stock (“Bear Market”) declines. This will make it necessary to put in place a strategy that will proactively manage future levels of stock market exposure to moderate losses from future serious stock market declines.
Such declines occur regularly and so far, all members of the “baby-boomer” generation that are now entering their retirement years have experienced twelve (12) such declines during their lifetimes since 1949.
In the past, retirees could invest savings in government bonds yielding high levels of interest, which reduced the need to include much more volatile stock market investments. As a result, portfolios of the past generation of retirees were mostly invested high-quality bonds.
Today, (with 10-year government bonds yielding very low returns, longer life expectancies, high health care costs, and the potential for higher inflation) retirees will find it necessary to allocate a larger portion of their savings into more aggressive stock market investments. This will force many retiree portfolios to take on more risk than wanted, making them more susceptible to incurring significant and permanent damage during negative stock market periods.
In the past positive fixed-income returns contributed to portfolio stability by offsetting negative stock returns during “bear” stock market declines. Unfortunately, for the “boomer” generation of retirees, fixed-income securities will no longer provide this benefit for the foreseeable future.
The presence of historically low interest rates from today’s fixed-income investments has eliminated the potential for a repeat of the positive returns earned over the last twenty years.
During the working lifetime of “baby-boomers”, the average level of interest that Federal Reserve Funds have paid has been 5.6%. That means that half of that time it has been higher and half of the time it has been lower. In the past, it has been as high as 16.39% during the inflationary times of the early 1980s.
Over the last twenty (20) years, that interest rate (that directly influences the interest rates paid for all types of fixed-income securities) has fallen from a high of 6.24% in 2000 to a record low of 0.09% in 2014. It ended 2016 at 0.39%. Since declining interest rates cause existing fixed-income investment to appreciate, the decline during this time has been very beneficial in helping to secure significantly higher positive returns for retiree portfolios that have fixed-income investment allocations.
As our economy recovers from the 2008 “Great Recession”, the future direction of interest rates has nowhere to go but up (since they are not likely to fall below a zero percent rate of return). In returning to a reasonably healthy level of economic activity, the Fed Reserve Funds rate will likely return to a level that is at or above 5.6%. This will result in lower future returns and, in many instances, negative returns for fixed-income portfolio allocations.
The benefit that is seen in Example #2 below (that shows the beneficial affect that fixed-income securities have had in stabilizing portfolio values) will be mostly absent for “baby-boomer” retirees.
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[For simplicity, the following tables assume net investment returns for equities (stocks) that match S&P500 index returns and for fixed-income (bonds) Vanguard’s Intermediate Bond Index Fund. The annual withdrawal amount is set at 4.0% of the portfolio value. Yearly inflation for the withdrawal amount has been set at 3.0%, which is close to its long-term historical average.]
Example #1-(assumes 100% stock portfolio):
Year Portfolio Value Market Gain/Loss Withdrawal / Percent
2000 $2,500,000 ($227,500)@ -9.1% ($100,000) 4.0%
2001 $2,172,500 ($258,528)@ -11.9% ($103,000) 4.7%
2002 $1,810,972 ($400,225)@ -22.1% ($106,090) 5.9%
2003 $1,304,657 $374,437 @ +28.7% ($109,273) 8.4%
2004 $1,569,821 $141,284 @ +9.0% ($112,551) 7.2%
2005 $1,598,554 $47,000 @ +3.0% ($115,928) 7.3%
2006 $1,529,626 $208,029 @ +13.6% ($119,406) 7.8%
2007 $1,618,249 $56,639 @ +3.5% ($122,988) 7.6%
2008 $1,561,900 ($601,332)@ -38.5% ($126,678) 8.1%
2009 $833,890 $195,964 @ +23.5% ($130,478) 15.6%
2010 $899,376 $115,120 @ +12.8% ($134392) 14.9%
2011 $880,104 $0 @0.0% ($138,424) 15.7%
2012 $741,680 $99,385 @ +13.4% ($142,577) 19.2%
2013 $698,488 $206,752 @ +29.6% ($146,854) 21.0%
2014 $758,386 $86,456 @ +11.4% ($151,260) 19.9%
2015 $693,582 ($6,935) @ -1.0% ($155,798) 22.5%
2016 $530,849 $50431 @9.5% ($160,472) 30.2%
(21% of the portfolio remains and the withdrawals have reached 30%)
Example #2-(assumes 60% stock / 40% bond portfolio):
Year Portfolio Value Market Gain/Loss Withdrawal / Percent
2000 $2,500,000 ($10,500) @ -0.04 ($100,000) 4.0%
2001 $2,389,500 ($82,477) @ +3.5% ($103,000) 4.3%
2002 $2,204,023 ($126,407)@ -5.7% ($106,090) 4.8%
2003 $1,971,526 $243,589 @ +12.4% ($109,273) 5.5%
2004 $2,105,842 $103,301 @ +4.9% ($112,551) 5.3%
2005 $2,096,592 $39941 @ +1.9% ($115,928) 5.5%
2006 $2,020,605 $159,571 @ +7.9% ($119,406) 5.9%
2007 $2,060,770 $90,860 @ +4.4% ($122,988) 6.0%
2008 $2,028,642 ($320,228)@ -15.8% ($126,678) 6.2%
2009 $1,581,736 $154,907 @ +9.8% ($130,478) 8.2%
2010 $1,606,165 $110,190 @ +6.9% ($134,392) 8.4%
2011 $1,581,963 $48,092 @ +3.0% ($138,424) 8.8%
2012 $1,491,631 $83,497 @ +5.6% ($142,577) 9.6%
2013 $1,432,551 $111,101 @ +7.8% ($146,854) 10.3%
2014 $1,396,798 $84,280 @ +6.0% ($151,260) 10.8%
2015 $1,329,818 ($2,565) @ -0.2% ($155,798) 11.7%
2016 $1,171,455 $42,442 @ +3.6% ($160,472) 13.7%
(47% of the portfolio remains and the withdrawals have reached 14%)
Conclusion:
The results illustrated in "Buy-and-Hold" Example #2 can no longer be expected to occur in the future, because fixed-income securities will no longer provide the necessary returns to adequately buffer future serious stock market (“Bear Market”) declines. This will force many retiree portfolios to take on more risk than wanted, making them more susceptible to significant and permanent damage from these declines. For present and future retirees, it is now necessary to put in place a strategy for equity investments that will proactively manage future levels of stock market exposure to protect portfolio values.
Greg Tinaglia
Last Updated: 01/12/2017