Diversifying Beyond Bonds in Retirement Planning

The Retirement Challenge

Between advances in healthcare and an increased emphasis on better living, the average retiree can expect to live roughly 20 years after retirement. This represents a marked increase in average life expectancy compared to 50 years ago.

In theory, this is progress. But in our current economy, it can also pose a challenge.

Consider that:

• The median retirement age in America is 62, while the median expected retirement age is 65.
• 58% of retirees retired sooner than planned, largely due to unforeseen circumstances such as health reasons or loss of employment.
• Of these retirees, only 21% retired due to their financial ability to do so.
• 57% of American workers feel behind on where they should be in their retirement savings.

If we’re expected to live longer lives in retirement, then we need to reexamine the math that formed the foundation of our financial planning 50 years ago.

For boomers and beyond, it might be time to reevaluate how you invest for the future.

Balancing Risk Exposure With Retirement Realities

The average consumer’s road to retirement often includes a strategy rooted in Modern Portfolio Theory. This is the idea that investing in a variety of asset types that tend to perform differently in the same economic climate can help to minimize the risk of profound financial losses.

From a retirement planning perspective, there are two approaches generally considered for diversification. In one approach, you could look at the entirety of your wealth and how it is being stored. This includes everything from savings to real estate, stocks, and more. In another approach, you could consider diversifying your investment portfolio specifically. For those gearing up for retirement, investment portfolio diversification is the primary point of concern, as your investment portfolio has a higher potential to generate greater returns.

This broadly means allocations to asset classes considered safe or conservative – like bonds – and those considered risky – like stocks. Financial planners will overlay this framework with discussions about an individual’s risk tolerance relative to their available risk capital and financial goals.

It boils down to two things: how much can you afford to lose, and how much are you comfortable losing?

Someone with a great deal of available capital in their 30s or 40s can probably afford to allocate more of their investment portfolio to higher-risk investments. In theory, they have the earning potential and time to make up potential losses. On the other hand, a retiree in their 70s might not have the sufficient income needed to weather a substantial loss if they want to remain financially secure.

Conventional wisdom states that, as you age, you should shift your investment portfolio away from risky holdings into more conservative allocations. This gets simplified into something known as the Rule of 100. Essentially, if you subtract your age from 100, that number is the percentage of your total wealth that should be invested in risky investments.

However, increasing longevity may mean that this conventional wisdom no longer holds true. If more wealth is required for a long, comfortable retirement, then more risk exposure may be required to reach your financial goals.

Revisiting the Bond Benefit

Bonds – particularly US treasuries – are traditionally considered a safe play in portfolio management. Backed by the full faith and credit of the US government and less vulnerable to major market shocks, treasury bonds are often framed as a conservative and reliable long-term investment. Investors tend to shift their assets into bonds, particularly during times when the stock market experiences greater volatility.

However, bonds are still affected by the broader economy and interest rates. Bond investors learned this the hard way in 2022, the single worst year for US treasuries on record. This was due to the Federal Reserve hiking interest rates in response to record levels of inflation.

2022 was an outlier year that also saw the worst stock market crash since 2008. Bonds and stocks are typically inversely correlated, so the simultaneous crash of both markets resulted in compounded investment losses and called into question the Modern Portfolio Theory and the Rule of 100.

Since then, the US economy has experienced a positive trajectory, with the Treasury yield curve flattening after being inverted for most of the past two years. Despite these signs of recovery, 2022 still demonstrates that bonds, while safe, are not without their risks in volatile markets.

Given this, diversifying your portfolio mix, particularly in the current economic climate where other assets are providing higher returns, can be a wise approach.

Portfolio Options in Retirement

Between life expectancy trends and evolving market dynamics, it is important to regularly evaluate your portfolio’s diversification. Rather than relying on bonds as an evergreen safety net, investors should consider the following alternative approaches to investment diversification.

Explore Other Fixed-income Opportunities

When most people talk about portfolio allocations to bonds, they’re referring to government treasuries. However, those aren’t the only fixed-income investments on the market. Certificates of deposit (CDs) and money market funds are attractive alternatives for those seeking to preserve capital and generate income.

Expand Into Different Asset Classes

Most investment portfolios consist of more than just stocks and bonds, but making deliberate allocations that give you exposure to specific asset classes can strengthen your portfolio’s overall diversification.

An example is investing in a Real Estate Investment Trust (REIT). REITs can give you exposure to real estate as an asset class at a lower price tag and tax burden compared to buying real estate outright. This can also provide more liquidity than what you would gain through a direct real estate acquisition, giving you additional flexibility in retirement.

Consider Allocations To Alternative Investments

We’re not just talking about alternatives to bonds here. Alternative investments come in all shapes and sizes, from commodities to direct investments and beyond.

Though not considered defensive investments, such allocations can provide significant portfolio diversification value. When traditional asset classes were in freefall in 2008, for example, managed futures hedge funds posted an average annual return of +6.7%. Most alternative investments are only accessible to accredited investors, though, so this approach may not be an option for the average consumer.

Think Outside the Box

Investment portfolios usually focus on traditional investment vehicles and asset classes. But there’s more than one way to skin a cat so to speak.

Investing in less liquid assets like collectibles can be an excellent way to grow your wealth while pursuing your passions. Such investments are not a sure thing by any stretch of the imagination. After all, various hobby markets have experienced their own bubbles and crashes. But investing in a tangible asset that appeals to a niche market can lead to value appreciation over time.

In Volatile Times, Consider Going Back To Cash

Ideally, your investment portfolio is actively working to make you money and it outpaces the interest rate you earn on cash. That being said, when market dynamics start to significantly deviate from the mean, keeping your assets in cash can protect them from higher than usual volatility.

Depending on where you are in life and your level of risk tolerance, this type of defensive positioning may not be necessary. Balanced, long-term investments, historically, yield the greatest results. But if your risk tolerance is low and you’re hoping to stretch your savings further for a longer retirement, then thoughtful portfolio shifts can be beneficial.

Adapting To the New Normal

At the end of the day, being able to enjoy a longer and earlier retirement is a good problem to have. It prompts us to pay attention to retirement planning, and to diversify our current investment portfolios to secure a better future.

Not everyone’s strategy requires the same shifts and each person’s circumstances are unique. Your best bet will always be to reach out to a professional for guidance. Don’t be afraid to ask questions and bring your own ideas to the table. If you play your cards right, you can worry less about living longer and focus more on living better in the latter stage of your life.

We think you’ll also like:

1. The Good, The Bad, and The Ugly Truth of Retirement Savings
2. Money Basics Series – Part 6: Protect Assets and Your Future Nest Egg
3. Invest Tax-Advantaged Retirement Funds in Private Equity for Growth

[Editors’ Note: To learn more about this and related topics, you may want to attend the following on-demand webinars (which you can view at your leisure, and each includes a comprehensive customer PowerPoint about the topic):

1. Real Estate Investing 101
2. How To Sell A Business A Step By Step Guide
3. Tech Talk: Current Opportunities for Investing

This is an updated version of an article originally published on February 28, 2023.]

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