By Anthony C. Kure
Many of us fondly look back on the 1980’s. The music, TV, movies and style are distinctly memorable. For savers and retirees, there is nostalgia for the higher interest rates. These higher rates on bonds and cash, sometimes in the double-digits, generated healthy income. Some retirees could fund all their needs with the interest income from a portfolio of all bonds. When supplemented by Social Security and even a pension, much more common then, investors were less dependent upon stocks, and as a result, less concerned about volatility.
Today the notion of living off bonds alone is unrealistic for a vast majority of investors. Yields on the 10-year U.S. Treasury note are less than 1%. High-quality corporate bonds yield a little more, but not much. So retirees living off their investment portfolio need a growth engine to keep up with inflation and sustain purchasing power. That growth engine is stocks.
Stocks have a long track record of outpacing bonds, but at a cost. 2020 has served as a reminder that stocks can generate gut-wrenching paper losses. Without the proper approach and mindset, these market declines sometimes lead to panicked reactions. Some simply can’t endure and decide to sell all their stocks in hopes of avoiding further pain. This reaction may provide a little better sleep in the short-term, but it also locks in permanent losses, jeopardizing the success of a retirement plan.
So what can be done to avoid such a disaster?
Stocks are always volatile from time-to-time, but 2020 has been the most volatile market since the Great Depression. Perspective on the long-term history of bull and bear markets informs wise portfolio construction. Since 1926, once a bear market begins (a 20% decline from the peak) it has taken 3.3 years on average to recover to the previous peak (including dividends and factoring inflation). In 2008, it took 5.3 years, in 2020 (so far) it took less than 3 months!
Fortunately, even in this low-rate environment it is possible to construct portfolios to benefit from the growth provided by stocks and still be able to sleep at night.
- Start by setting aside the next 12 months of living expenses in cash. This provides a guaranteed amount for the funds needed to pay the bills.
- Second, invest 3 to 7 years’ worth of living expenses in high-quality bonds (including anticipated one-time expenses such as weddings and vacations). This provides modest income and, critically, safety when stocks inevitably hit hard times.
- Third, allocate the remainder of the portfolio to a diversified mix of high-quality stocks. Long-term investors willing to endure stock-market volatility have always been compensated over time with higher returns than bonds, both by increasing prices and increasing dividend payments.
- Finally, stick to the strategy by periodically rebalancing to the initial targets and avoiding major shifts based on emotion.
Investors should stay informed, but there are good and bad ways to keep up with the news. The financial media need revenue from advertising, and advertising is driven by attracting attention. Fear sells. Exaggerated headlines draw attention, but lead to ill-advised decisions. When there is doom and gloom, remember the strategy described above allows four or more years to wait for the stock-market to recover. In this world there are always headwinds, sell indicators, and crises. By knowing history and structuring the portfolio for success investors can tune out the noise and focus on enjoying life to the full.
Johnson Investment Counsel cannot promise future results. Any performance expectations presented here should not be taken as any guarantee or other assurance as to future results. Our opinions are a reflection of our best judgment at the time this interview occurred, and we disclaim any obligation to update or alter forward-looking statements as a result of new information, future events or otherwise.
Johnson Investment Counsel is a Goering Center corporate partner, and the Goering Center is sharing this content as part of its monthly newsletter, which features corporate partner articles.
Anthony C. Kure, CFP®, is the Director at Northeastern Ohio Market, Portfolio Manager for Johnson Investment Counsel. Reach Anthony at 440-377-5696 or by emailing him here.
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