Rebuilding the Retirement Planning Buckets

As the COVID-19 pandemic swept the country, we first reported this event’s game-changing effect on retiree income, specifically for those who recently retired or were about to retire.
Many individuals do not fully understand how the pandemic (and now the Ukraine invasion) has fundamentally changed retirement planning. Many who do, feel forced to take on more risk or make little or no money on “safer” investments.

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In times of crisis, fiscal policy lowers interest rates to stimulate the economy. The problem retirees have is that leverage is now ratcheted down to a real return of zero. For other economic purposes and for retirees to generate income on “safer” money, the Fed will now start to raise interest rates.
However, it’s not the end of the story. Many retirees often hold significant cash and bond positions following the traditional approach to risk-aversion in retirement.

Why interest rates matter

By the Fed raising interest rates, the coupon value of newly issued bonds (or the interest a bond pays) will continue to pay the old lower interest rate until maturity. If the bond is sold before maturity (which makes sense if one wants to capture higher and higher coupon rates), that means that the bondholder takes a “discount” or a loss on “par value” when the bond is sold.

No one is buying a lower-yielding bond without the owner taking a “discount.”

Because bond values are so closely correlated to interest rates, it’s now challenging to find reliable income from “safer” investments. This phenomenon goes well beyond just bonds. In many cases, alternative “safer” financial instruments (such as life insurance, annuities, and some types of pensions) are primarily based on current bond rates when setting up a contract. That naturally draws additional scrutiny for these types of financial instruments. It doesn’t mean they are inappropriate; it just means the planning process requires an objective discussion of the viability of these instruments as new investments.

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As for bonds currently in inventory, the expectation is that they will lose “par value” as rates go up, albeit while still collecting the stated interest rate. With a laddering system, bonds will earn higher and higher coupon rates, but the drag on any net return factoring the discount will remain evident.

Recommendation: Top 15 Retirement Planning Mistakes to Avoid

So… where’s the income?

The short answer is nowhere. At least probably not without taking additional risk. I see many financial plans with a lot of cash (making nothing and losing to inflation) with significantly more money in longer-term equity investments doing the heavy lifting against inflation. As you might know, in general, riskier investments are typically most suitable attached to longer-term timelines and, as a result, can absorb the volatility over the long haul.

If retired, you get it. If you are soon to be retired, it’s ALL about income.

The little engine that can’t go

The medium-term money is where I am most concerned for my clients. If you are retired or retiring, the income historically generated in brokerage accounts (generally considered 3-5 year money) remains a glaring question mark. That question is, how do I make money without taking significant risk with equities? But there may be nothing to do but wait.
I’ll sometimes describe medium-term money as the “little engine” of the retirement portfolio. It acts as a dynamic income-driving machine for retirement plans in many ways. These full-sized vehicles enjoy containing income-generating asset classes (Corporate Bonds, Municipal Bonds, Dividend Stock, Junk Bonds, Alternatives & Real Estate). It’s nice to have them supplement short-term money, ideally without the need for taxable withdrawals from retirement accounts.
But, with low-interest rates, all the options on this list become much less viable; the exception is possibly buying real estate for income. However, don’t think real estate is “risk-free.” Real estate has its unique risks to consider as an asset class, and trading one risk for another is still a risk.

So… sell all my bonds?

I’m not suggesting you go there. But it seems pretty safe to say that new money into bonds is debatable, at least right now. So perhaps the real question is …if not bonds, then what? Usually, that means the individual keeps the money in cash (risk-free) or invests in something else, likely meaning more risk. The thought of retirees taking additional risk beyond what’s comfortable is very troubling.
Souring on bonds and haphazardly selling in a panic due to one blog article is NOT advisable. There should be a proper examination and rational process to decide what (if any) bonds to buy, sell or salvage. That’s the case for any consequential financial decision. Remember, one of the primary reasons to have a bond is its insulation against a downturn. Even if a bond is not paying and possibly losing money, this is still true. Let’s be clear. Bonds remain a viable hedge against market risk.

Losses Hurt

*This chart represents no specific investment or strategy.

Retirees, get your ladders ready

As the Federal Reserve raises interest rates, the time-tested bond laddering strategy will resurface. This is the technique to purchase bonds as rates go up so that the investor is continuously capturing higher and higher yields of newly issued corporate, municipal, and government-backed bonds.
The yield (and reliable income) remain despite the reality that bond values will still affect those seeking income. Of course, timing in getting started is what we say is the hardest part of investing.

New solutions will soon emerge

How much of the world’s retiree money will remain sitting on the sidelines? What viable income and cash solutions will emerge thanks to blockchain technology? We predict that soon we’ll see increased competition in the financial services industry and new legitimate blockchain-based solutions for retiree income. It has to happen.

Editor’s note: This blog offers informal investment and financial planning advice. We know nothing about your unique financial situation. The buying and selling of any financial product or security should only be considered in context. If appropriate, seek the counsel of experienced, ideally objective, financial, tax, or estate planning professionals. Past performance is not indicative of future performance.