The Case for Bucking Bonds in Retirement Planning

Between advances in healthcare and an increased emphasis on better living, the Social Security Administration tells us that the average retiree should expect to live roughly another 20 years after retirement. This represents a marked increase in average life expectancy compared to 50 years ago. 

In theory, this is progress. But for the 55% of Americans who report being behind the curve in terms of saving for retirement, it’s a challenge.

Most entering retirement today will rely on savings and their investment portfolio to see them through their twilight years. They’ve scraped and prepared for this new chapter their entire lives. But if we’re living longer, the math that formed the foundation of our financial planning 50 years ago is woefully out of date.

So what has to change? For Boomers and beyond, it might be time to reevaluate how we 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 mathematical framework is guided by the idea that investing in a variety of asset types that tend to perform differently from one another in the same economic climate helps minimize the risk of profound financial losses. 

There are two ways to view this type of diversification from a retirement planning perspective. In the first, you 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 the second, you consider diversification within your investment portfolio, specifically. Your portfolio has a higher potential for generating larger returns than, say, an interest-bearing savings account. As such, investment portfolio diversification is a primary point of concern for those gearing up for retirement. 

For most investors, this means allocations to asset classes considered “safe” or defensive – like bonds – in addition to those considered “risky” – like stocks. Financial planners will overlay this framework with discussions about an individual’s risk tolerance relative to 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?

For example, someone with a great deal of available capital in their 30s or 40s can probably afford to allocate more of their investment portfolio to “risky” investments. In theory, they have both the means and time before retirement to make up their losses. On the other hand, a retiree in their 70s might not have the stomach or leeway to risk a substantial loss if they want to remain financially secure.

Conventional wisdom is that, as you age, you should shift your investment portfolio away from risky holdings and 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 so-called “risky” investments – or investments with higher levels of volatility than others.

But increasing longevity may mean that this conventional wisdom no longer holds true. If more wealth is required for a comfortable retirement than before, it stands to reason that more risk exposure is required to reach your financial goals. 

Singing the Bond Market Blues

Bonds – particularly US treasuries – are considered a traditional safety 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.

But as the economy evolves, so too do market dynamics. Bond investors learned this the hard way in 2022, which was the single worst year for US treasuries on record. As CNBC reports:

[T]he Total Bond Index […] tracks U.S. investment-grade bonds, which refers to corporate and government debt that credit-rating agencies deem to have a low risk of default.

The index lost more than 13% in 2022. Before then, the index had suffered its worst 12-month return in March 1980, when it lost 9.2% in nominal terms, [Santa Clara University professor Dr. Edward] McQuarrie said.

[…]

The longest U.S. government bonds have a maturity of 30 years. Such long-dated U.S. notes lost 39.2% in 2022, as measured by an index tracking long-term zero-coupon bonds.

That’s a record low dating to 1754, McQuarrie said. You’d have to go all the way back to the Napoleonic War era for the second-worst showing, when long bonds lost 19% in 1803.

Those figures are absolutely staggering. Given that, as of January 2023, the total size of the U.S. treasury market is more than $24 trillion, the losses sustained by investors were not insubstantial. 

Broader economic trends made poor performance in the bond market even more painful. Though stocks and bonds are typically inversely correlated, 2022 was the worst year for the stock market since 2008. The cumulative losses, paired with still-too-hot inflation, put retirees and those headed in that direction in a difficult position.

Traditional Investment Portfolios are Struggling

The gravity of the situation is best understood through an example. Let’s assume:

• The average retirement age in the US is 64, and retirees can expect to live another 20 years after that.
• On average, Americans have roughly $400,000 set aside by the time they retire.
• Using the Rule of 100, let’s assume that this average retiree has 36% of their retirement savings allocated to “risk” – meaning market investments – for a total of $144,000. For simplicity’s sake, we’ll assume the remainder of their retirement savings is in an interest-bearing savings account in line with the national average of 0.35% annual percentage yield (APY).
• Presume that the entirety of the investment portfolio is allocated using one of the most basic iterations of Modern Portfolio Theory – the 60/40 portfolio. In this case, an investor would allocate 60% of their available risk capital to stocks and 40% to bonds. 

Using the S&P 500 and Vanguard Total Market Index Fund as proxies for stock and bond investments respectively, 2022 was incredibly ugly. This mock investment portfolio would have lost nearly 17%, leading to total retirement savings depletion of over 6% in one year alone.

In fairness, most retirement savings and strategies are more complex than our example suggests. But the main takeaway is this: traditional applications of Modern Portfolio Theory and the Rule of 100 aren’t working anymore – especially when it comes to bonds.

Life After Bonds: Portfolio Options in Retirement

Between life expectancy trends and evolving market dynamics, our understanding and pursuit of diversification options in our investment portfolios need retooling. If bonds no longer provide the diversification value they once did nor sufficient returns to support retirement, alternatives must be weighed. 

Explore other fixed-income opportunities.

When most people talk about portfolio allocations to bonds, they’re talking about government treasuries. Those aren’t the only fixed-income investments on the market, though. For example, certificates of deposit (CDs) and money market funds may be attractive alternatives for those seeking to preserve capital and generate income.

Expand into different asset classes.

Most investment portfolios include more than just stocks and bonds anyway, but making deliberate allocations that give you exposure to specific asset classes – regardless of the investment vehicle used – can help strengthen your portfolio’s overall diversification.

Investing in a Real Estate Investment Trust (REIT), for instance, can give you exposure to real estate as an asset class at a lower price tag and tax burden than, say, buying real estate outright. This can also provide more liquidity than you would 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. Investments classified as “alternatives” are a totally different animal. 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.

When discussing investment portfolios, we’re usually talking about traditional investment vehicles and asset classes. There’s more than one way to skin a cat, though. 

Depending on your current savings and financial goals, investing in less liquid assets like collectibles might be an excellent way to grow your wealth (and pursue your passions). Such investments are not a “sure thing” by any stretch of the imagination. They do, however, present an opportunity you may not read about in financial papers.

Pivot to cash… for a while. 

Ideally, your investment portfolio is actively working to make you money. If your money is sitting still, that doesn’t happen (at least, not to the same extent). This being said, when market dynamics start significantly deviating from the mean, keeping your assets in cash can protect them from higher-than-usual volatility. 

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

Adapting to the New Normal

We’re not saying that you shouldn’t invest in bonds at all. In many cases, your portfolio will still benefit from some allocation to the asset class. What we’re saying is that the nature of that benefit is changing. If you’re currently retired or are preparing for retirement, your bond investment strategy might need an update. 

That doesn’t mean everyone’s strategy requires the same shifts. 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 set yourself up to worry less about living longer and focus more on living better.

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©2023. DailyDAC^TM, LLC d/b/a/ Financial Poise^TM. This article is subject to the disclaimers found here.