In 1991, investors needed to know only two things about the
positioning of their investment portfolio as they entered retirement; move to a
higher allocation of bonds, and fill the rest of the portfolio with large,
well-known American stocks. Amazingly,
this simplistic approach proved quite successful throughout the 1990’s. However, investors facing retirement
investment decisions today are unfortunately in a far more precarious position.
Just a few years ago, investors witnessed the culmination of
a multiple-decade bull market for large U.S. stocks. Despite the recent three-year bear market, large U.S. stocks,
historically speaking, are still in the top ten percent of highest valuations
ever. The outlook for bonds is not much
better. We are now facing what appears
to be the finale of a twenty-year bond bull market. This is because bond prices tend to move in the opposite
direction of interest rates. With
interest rates steadily declining for the past twenty years, bonds enjoyed an
unprecedented period of excellent performance.
Now that interest rates are near all-time lows, continued strong
performance from bonds is unlikely.
For investors with a lengthy investment time horizon
(twenty years or more), an extended market correction may not be so
damaging. But those that have an
intermediate timeframe (ten to fifteen years) sub-standard returns in both the
equity and fixed income markets may prove disastrous for investors nearing or
who are already in retirement. To add
to these difficulties, inflation is likely to gradually increase. With bonds and stocks poised for at least a
decade of mediocre performance (4% to 5%, according to legendary investors
Warren Buffett and Bill Gross), where will retired investors and those nearing
The well-diversified portfolio, much as it has in years
past, will still serve the retired and near-retired investor well. The difference this time, is that investors
must be willing to incorporate different asset classes into their portfolio;
asset classes that do not normally move in the same direction with one another.
This means that they typically react
differently to market conditions, and thus offer downside protection when one
of the asset classes may be underperforming.
Examples of such asset classes are hedge-like investments, commodities,
and real estate (in the form of Real Estate Investment Trusts). While these investments may sound
complicated and risky, they are not.
Actually, most are less risky than most domestic stock portfolios and
are available in a standard mutual fund format. These types of investments have helped investors essentially
avoid losses for the past three years.
These types of investments, when combined with more
traditional investments like stocks and bonds, can produce superior performance
with significantly less risk, in fact, almost bond-like risk. Although bonds do not fare well in rising
interest rate markets, certain fixed income investments will do well when
interest rates rise because the rate of return they receive will adjust upward. Examples of these include stable value
funds, bank loan funds, and TIPS (Treasury Inflation-Protected Securities).
By investing their portfolios in the manner described above,
retired individuals, and those nearing retirement, will be able to preserve
wealth, receive cash flow from their portfolio, and stay ahead of inflation
while obtaining returns not possible from the standard large U.S. stock and
bond mix that served investors so well in the 1980’s and 1990’s.
For further information, contact
Louis P. Stanasolovich, CFP™ at (412) 635-9210 or e-mail him at email@example.com.