Retiring soon? Congratulations. It's a good time to take some risk out of your portfolio.
Advisors typically recommend that investors boost their bond allocation heading into retirement, and strong stock returns and rising bond yields have created attractive conditions for the move. The S&P 500 index is up 13% this year, while the yield on the 10-year Treasury note has climbed to 4.6%, up 0.46 percentage point.
"This is like the best of all worlds for retirees," says Brad Conger, chief investment officer at investment firm Hirtle & Co.
The sharp uptick in yields means paper losses for bondholders, since bond prices move inversely to yields. While that might be unsettling for retirees with existing bond portfolios, it presents a nice entry point for those adding to their fixed-income position.
Plump yields should also ease the sting of paring stock gains. The S&P 500 returned nearly 80% over the past three years, and while it might be tempting to let your winners continue to ride, investors nearing retirement are vulnerable to so-called sequence of returns risk -- the risk of retiring into a downturn. Withdrawing money from a declining balance can deplete your savings much quicker than withdrawing from a rising or even flat balance.
There's no one-size-fits-all mix, but the classic 60/40 portfolio is a good place to start. If you have a generous pension, you can probably afford to have more than 60% in stocks. If market gyrations keep you up at night, you might prefer less. Exchange-traded funds like iShares Core 60/40 Balanced Allocation offer one-stop shopping for hands-off investors.
Volatility has abated for the moment, but it hasn't gone away. Strong earnings have propelled stock gains this month after a semiconductor selloff in late July. Yet many expect more choppiness to come in both the equity and the bond markets.
A trillion-dollar question looms over the markets: Will the massive capital expenditure that mega tech companies are making in their artificial-intelligence buildouts result in gains that justify their investment?
"As a society, we've made a gigantic bet on this working out," Conger says.
Hyperscalers like Amazon.com, Meta Platforms, and Oracle are financing their capital expenditure with cash and, increasingly, debt. Market participants have worried that these investments are eating into companies' free cash flow, leaving them more vulnerable if their bets don't pan out.
The bear case could be positive for bonds. If the AI buildout is a bust -- that is, if it doesn't earn hyperscalers enough to recoup their investment or produce productivity gains without widespread unemployment -- the economy could tip into a recession. The Federal Reserve would then have a clear case for lowering interest rates, pushing bond yields down and prices up.
Yet you don't have to expect the worst to feel comfortable. Over intermediate to longer horizons, the starting yield of the Bloomberg U.S. Aggregate Bond Index, known as AGG, is a strong predictor of your future total return. Right now, it stands around 4.9%, about two percentage points above the 15-year average, according to Vanguard. To be sure, inflation is higher than at other times during that period, reducing your real yield, but it's still a respectable starting point.
Current yields can provide protection against the kind of losses that fixed-income investors saw in 2022. At today's AGG levels, yields would have to rise more than 0.81 percentage point over the next 12 months before an investor loses money on a total-return basis, according to Vanguard -- and that's a bigger cushion than most of the time in the past couple of decades.
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