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REMEMBER WHEN YOU got that first AARP card in the mail? I must have been 50, not at all ready to begin thinking about senior discounts, and slightly offended. That was 12 years ago.
Well, I’m feeling that way again. You see, the grim reaper—oops, I mean retirement—is getting close. That means it’s time to reduce my exposure to stocks, while boosting my holdings of income-oriented investments. It’s a strange feeling for someone who has spent his life investing almost exclusively for capital appreciation.
On the one hand, such an adjustment in my asset mix should be strictly by the book, as though I’m running my own target-date fund. Unemotional, mechanical, and free of any ideas about tactical asset allocation. Just part of a long-held plan.
On the other hand, I’m concerned about a richly valued stock market propped up—at least until recently—by the “magnificent seven” glamour stocks. In response, I’m considering a tactical move: a bigger cut in my stock allocation than I’d initially planned and, with part of the proceeds, a bet on both high-quality and high-yield corporate bonds.
Over the next 10 years, some experts project that bonds could match or beat the stock market indexes. Asset management firms like Vanguard Group, PIMCO and Oaktree Capital Management are pounding the table for bonds. In fact, Oaktree Co-Chair Howard Marks is calling for a fundamental reassessment of the typical stock-bond mix in favor of more bonds, especially corporates.
My old plan was to reduce my stock allocation from its current 72% in increments of one or two percentage points per year as I age. I planned to shift money to short-term Treasurys and other safe options, which I’ve generally preferred for the bond and cash part of my portfolio. That’s partly because part of the 28% non-stock part of my portfolio doubles as my emergency fund.
But even though I already have a hefty allocation to safe bonds and cash, I feel exposed to the risk that the tech giants that dominate the U.S. market are overvalued. Experts talk about the high Shiller cyclically adjusted price-earnings ratio of 32, the low stock market risk premium and—by historical standards—the low S&P 500 earnings yield of 3.8%. Vanguard is projecting paltry returns of 4.2% to 6.2% annually for large-cap U.S. stocks over the next decade.
That makes me think of cutting perhaps three percentage points from my stock allocation at the end of this year—greater than what I’d planned. Instead of shifting that money into my usual safe-haven options, I’m considering an allocation to riskier vehicles such as corporate bonds, including high-yield “junk” bonds, in a bid for strong returns with less risk.
I already own some high-quality and high-yield corporate bonds, almost all through balanced funds that I inherited. I also have a very small and slowly growing position in a junk-bond fund in my 401(k).
Vanguard expects high-yield bonds to notch returns of 6.3% to 7.3% annually over the next 10 years, outperforming U.S. stocks. That’s not the same thing as recommending junk bonds right now. Vanguard’s fixed-income experts are concerned about a recession in 2024, and thus for the moment favor high-quality bonds.
Over most of my investment lifetime, the stock market has been driven in part by declining interest rates. But that favorable environment appears to be over, and today’s higher interest rates and rich stock valuations may now create a headwind for U.S. shares. Price-earnings ratios may not rise over time, as they have throughout the past four decades. Dividends from stocks and interest paid on bonds may become greater components of total return.
If you think stocks might return 8% or less a year over the next decade, rather than the 10% average annual return of the past century, then an investment-grade corporate bond fund with a 6% yield doesn’t look bad. In fact, in its capital markets assumptions, Vanguard projects intermediate-term corporate bond returns of 5.2% to 6.2% a year.
That could match or exceed those of U.S. stocks over the next decade—and do so with much lower volatility. Still, market action could influence my decision, especially if the yield advantage of corporate bonds over Treasurys narrows too much.
William Ehart is a journalist in the Washington, D.C., area. In his spare time, he enjoys writing for beginning and intermediate investors on why they should invest and how simple it can be, despite all the financial noise. Follow Bill on X (Twitter) @BillEhart and check out his earlier articles.
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The firms who are predicting great bond returns happen to make a LOT of $$$$ on bond sales. Take it with a grain of salt because even THESE experts do not know what will happen for sure. Be careful with projections.
Hi William,
A video/podcast I digested yesterday from respected researchers and investing folks made me question the conventional wisdom about stocks and bonds and percentages in retirement and turn my thinking on its head.
See https://rationalreminder.ca/podcast/284
The study referenced by researcher and professor Scott Cederburg included 13 countries, including the US, and hundreds of thousands of people and lots of data.
The study essentially questions the long-held belief that stocks must be buffered by some kind of bond or fixed income mix to mitigate stock market losses during downturns and avoid running out of money in retirement. It asserts that “ruin rates” (where a retiree runs out of money) are almost double for a mixed stock and bond/fixed income portfolio than for an all stock (50/50 domestic/international stock portfolio.
Yes, an eyebrow raising conclusion.
Scott urges more research aimed at studying a better approach than the Target Date Retirement (TDR) fund ramp up of bonds and fixed income in a portfolio with age, because the failure rate of this approach vs. the 50/50 dom/Intl. stock portfolio was so much higher.
His worry is that workers are funneled into the TDR fund at signup and many rarely revisit this until leaving the TDR fund or to retire.
I’m an old Dietitian, and it reminded me that new research can either add weight to existing beliefs, or turn them completely cattywompus, and forge a new understanding, much like the belief 30 yrs ago that eggs (a couple eggs a week) was contraindicated for those with high cholesterol. We now know that the body makes most of its own cholesterol (2/3) and that eggs contribute little to an escalating cholesterol level that requires intervention to prevent heart disease).
I’d certainly like some feedback from others on Humble Dollar about this. I’m a weekly reader and enjoy all the knowledge I’ve gained from writers and commentators alike.
This study was a whump upside the head for me, and I was glad I chose to get a 20 yr SPIA to fund my income floor in the years before I choose to start Social Security. That allows me to worry a LOT less about my portfolio ups and down and its higher stock percentage.
I wanted to retire once and never worked again. I came up with the following:
1) I read that you need a portfolio size of 10 times, maybe 15, your annual expense. My calculations came up with 20 times, based on LTC + increasing healthcare. I retired in 2018 with 25+ times and that did not include SS. After 6 years I have a lot more.
2) I believe in a reverse glide. The 5 years before retirement until age 70-75 are the most crucial. This is the period you can’t lose a lot because you may not have enough time/money to the end. You should be in the lowest long-term term % depending on the risk you like. Example: suppose you want to be at 50/50 in retirement, until age 70-75 hold only 30% in stocks, then increase 1% annually.
3) The less money you have the fewer options you have. If you don’t have enough, you must have a high % in stocks. When you have enough, at least 25 times without SS, you can have 30/70 to 70/30. The ones in the middle must make tougher choices.
4) I also believe in flexibility. There is no one withdrawal number for everyone and a retiree must follow the same rate all the time. Markets, inflations, and circumstances change all the time, and why a retiree can change too.
I don’t follow any of the common rules most follow or find in most articles/research. Since 2000 I developed my flexible investing style and risk and I still use them in retirement.
I “love” experts opinions.
Shiller: On May 20 (https://money.cnn.com/2012/04/10/pf/investing-Shiller.moneymag/index.htm).
Question: You have become famous for your cyclically adjusted 10-year price/earnings ratio. What do the latest numbers say about future stock market returns?
Shiller: we found a correlation between that ratio and the next 10 years’ return. If you plug in today’s P/E of about 22, it would be predicting something like an annualized 4% return after inflation.
FD: reality, the SP500 made 13.6% in the next 10 years (04/31/2012-04/31/2022). Let’s deduct the inflation and make it 11% which is almost 3 more times than his prediction. It also was much better than countries with lower PE10 such as Emerging markets
See many other predictions at https://fd1000.freeforums.net/thread/13/worse-experts-predictions
A few comments about the below responses:
1) Theoretically speaking if one is taking the much mentioned 4% withdrawl from retirement accounts, what’s so bad about a predicted 8% return on stocks?
2) Beware of junk bonds for “safer” assets as they tend to move in tandem with stock
3) You are right that a 3% change in your portfolio from my perspective is hardly market timing
That’s a lot of words to justify a 3% adjustment in allocation. 🙂 That said, your arguments for a higher bond allocation resonate with me-great to see a piece on bonds. I’m in the 50/50 Bernstein “if you’ve won the game why keep playing” camp.
Ask: How often are the so called experts correct?
Not too often
Thank you for the thought provoking article.
Many people are sitting on huge capital gains in the stock market, but are discouraged from selling by having to pay huge capital gains tax, and possibly IRMAA as well.
With more a more conservative portfolio, you at least get a stream of dividends, even if you don’t sell. Of course, your gains probably aren’t as large.
Isn’t this a form of market timing?
Thanks for your comment, it got me thinking. If I were slashing, say, 10 percentage points or more from stocks overnight I’d be more concerned. Two or three points, when the bulk of my investments are still in stocks, doesn’t seem like a big deal. If it’s a wrong move, I’ll pay a small price, as I should. Most people would still consider 69% in stocks a hefty allocation at my age. What concerns me more, in terms of decision making, is shifting from my preference for short-term Treasurys and the like toward more reliance on intermediate corporates. Do I really have a good reason for that?
Bill, in your last article you wrote that your bonds are for stability, not yield. Now their growing yield gives you reason to think about them not just for stability but in terms of competitiveness with stocks, as are the observers you cited. As sources of return, corporates may have more potential benefit than Treasuries. So yes, I think you have a good reason for leaning more toward corporates. Will it turn out to provide what you’re aiming for? That’s a different question that of course we can’t answer, but it seems like a good reason.
I enjoyed both articles btw!
If bonds are for stability, corporates are riskier. Stay with short term treasuries. Get the growth from stocks
William, thanks for writing — this is a thought-provoking contribution.
Oaktree’s Howard Marks, whom you cited, regularly opines that investors should be aware of their own personal concerns when choosing an investment strategy, specifically whether they worry more about the risk of losing money in the market or about the risk of missing an opportunity. Ultimately stress and worry are bigger risks than making asset allocation mistakes — you can recover lost money, but a lost night’s sleep is gone forever.
For most of my life I was a 100% equity investor who considered cash trash and regretted only the soaring stocks I didn’t buy. But now, at 67, I hold 40% bonds and a significant cash reserve. Yeah, I roll my eyes at some missed opportunities, but I sleep great.