The assumption that stocks are generally riskier than bonds seems to be a widely accepted piece of investment wisdom. If this were true, a bond-heavy retirement portfolio consisting of bond mutual funds or fixed income exchange-traded funds (ETFs) would make for a safer investment than a portfolio with a heavier stock allocation. The problem is this piece of “common wisdom” isn’t sound. In our view, it’s misguided.
Many investors who are entering or already in retirement want to know how much of their portfolio should be invested in stocks and bonds—and what the right mix of those assets should be in order to grow or receive income from their portfolio. Whether your goal is growth or income in retirement, your asset allocation should be in line with that objective because it can play a critical role in achieving your retirement goals.
Many investment managers rely on strategies where age is the main determinant of an asset allocation recommendation. However, this can be detrimental over the long term. For instance, not every retired 60-year-old has the same life expectancy or supplemental pension income. You may be looking to leave a legacy to heirs or spend all of your money in retirement. These are all individual factors that may be over-looked in a traditional age based asset allocation.
Investors often assume they should allocate a larger segment of their portfolio to bonds for several reasons, believing:
Low returns may shorten the length of time your portfolio can provide for you during your investment time horizon.
Not having enough money to cover your retirement—a potentially lengthy time horizon that can last up to 30 years or more—can be devastating. You may run out of money for several reasons, such as rising living costs, inflation, higher medical costs and, in some cases, supporting other family members during your retirement. As one would imagine, with the advances in medical technology, the average investor’s time horizon has significantly increased, thus leading to an increase in the growth needed to meet long-term objectives.
Low volatility doesn’t necessarily mean low risk.
Many investors assume investing in stocks is riskier than bonds, citing stocks’ higher volatility. But short-term volatility doesn’t necessarily lead to volatility in the longer term.
You might be surprised to learn that over longer periods, equities are actually less volatile than bonds. As the following charts illustrate, a stock’s standard deviation—a measure of the degree to which a stocks return deviates from its average return—tends to “smooth out” over time. Moreover, equities outperformed bonds 100% of the time during 30-year rolling periods and 97% of the time during 20-year rolling periods since 1926.1
As stock market gains have outperformed bonds over a 30-year period, you might want to consider a more stock-heavy portfolio allocation to achieve the growth necessary to cover your retirement.
Bonds’ inverse relationship.
A rise or fall in interest rates may work against your bond allocations. Bond prices and interest rates have an inverse relationship, meaning they move opposite one another:
If you reinvest in bonds when yields are down, you may end up spending more for smaller returns. And if you switch to higher-yielding bonds, you may end up investing in bonds that are inherently riskier due either to their lower credit quality or longer period to maturity.
Imagine the opposite scenario, one in which interest rates dramatically rise. Suppose you need to convert your bonds to cash due to unanticipated expenses, such as a large medical bill, a home purchase or any other necessary or discretionary purchase. Cashing out your bonds while interest rates are high means you may end up losing money, because you would likely receive less for the bonds than what you had initially paid.
In our view, using bonds to drive returns is a common mistake. We believe the primary benefit bonds bring is helping to reduce a portfolio’s volatility. Not everyone needs this feature, but if you have high cash-flow needs, it can make sense to help dampen the effect of the stock markets’ swings.
The good news is you don’t have to rely only on bonds to provide income after you have retired. You can use other approaches:
There is no one correct asset allocation strategy. Every investor has unique financial circumstances, goals and risk tolerance—but you don’t have to go it alone. At Fisher Investments, we provide you with an Investment Counselor and a dedicated team who are committed to understanding your financial needs. We can help you with strategic asset allocation between stocks, bonds and cash to diversify your portfolio investments and match your longer-term financial goals.
Contact us to learn more!
The contents of this document should not be construed as tax advice. Please contact your tax professional. Investments in securities involve the risk of loss. Past performance is no guarantee of future returns.
1 Source: Global Financial Data, as of 4/11/2017.