Rising interest rates, falling bonds and the possibility of the future

As interest rates rise, do you wonder if the bonds in your portfolio are still the smart investment you once thought?

If you have any doubts about bonds, you’re not alone. In the latter part of 2021, even Bill Gross, known as the “Bond King”, said that the bonds belonged to the “investment bin.”

Bonds generally have an inverse relationship with interest rates, which means that when interest rates rise, bond values ​​fall. With the current rise in interest rates, many people are wondering what they can put in their portfolio in exchange for bonds.

For many years, bonds have provided something of a safe haven to balance out the risk portion of a portfolio, especially for those approaching retirement. For example, if your mix was 60% stocks and 40% bonds, what should you do with that 40% if bonds no longer offer the security and stability they once did? Some adjustments may be necessary, but how do you get growth potential without taking too much risk?

One possibility is a fixed index annuity (FIA). People often think of an annuity as something that pays a guaranteed fixed amount of monthly income for life, much like a pension. This may be the case, but it may also be restrictive because once the amount of income is fixed, it is unlikely that it can be changed.

However, some AIFs focus on accumulation (i.e. growing your money) rather than providing a guaranteed income. Investing this way means you don’t have to lock in a fixed monthly withdrawal, but rather generate retirement income by withdrawing earnings and/or capital. It’s a bit like exiting a traditional stock and bond portfolio, using dividends and earnings to create income. The major advantage is that the capital and earnings are protected and cannot decrease, unlike bonds. Factors such as the economy, falling stock markets, etc. will not create losses in these types of annuities.

This is one of the great advantages of annuities – their advantage is potentially increasing when markets are up (with limits), but when markets are down, FIA values ​​stay up. This eliminates risk and makes AIFs a good option for those looking for a bond replacement. Two studies do a great job of making this point, each detailing a potential way forward for investors looking for this portfolio alternative.

Annuities and bonds: the very long-term vision

Let’s look at one of these studies. A few years ago, economist Roger Ibbotson studied nearly a century of market outcomes to create a hypothetical model comparing how AIFs would have performed against bonds. 1927 to 2016. Remember that 1927 is a few years before the stock market crash of 1929 that dragged us into the Great Depression.

What he and his team of researchers found was that, net of fees, AIFs had an annualized return of 5.81%, compared to 5.32% for long-term government bonds and 9.92 % for large cap stocks in this up and down period. yields.

In some years, when bond yields were particularly low, an AIF would have helped investors even more, Ibbotson found. In other words, a 60/40 mix of stocks and bonds was good; a 60/20/20 mix of stocks, bonds and annuities was preferred; and a 60/40 mix of stocks and FIA was best of all.

A more recent BlackRock study corroborated Ibbotson’s findings with three main conclusions:

  1. Adding FIA to a portfolio has added greater upside potential over years of average stock market performance.
  2. AIFs have improved the results of balanced portfolios during extremely bad market years.
  3. Incorporating AIFs can provide more certainty about the future values ​​of the portfolio in general.

BlackRock highlighted the importance of the sequence of return risk, which is how the order of investment returns affects a portfolio when withdrawals are made. If no withdrawals are made, the order of the returns does not matter. But when distributions are taken, early losses can have a devastating impact on a portfolio’s longevity, when those same later losses wouldn’t be so detrimental. By using AIFs as a replacement for bonds, BlackRock found better long-term results because AIFs protected against potential losses in early retirement.

BlackRock further mentioned that some investors have high cash positions to avoid potentially selling out of the market in the event of a loss. They suggest that the FIA ​​is a good cash replacement because it “retains its ability to hedge against negative outcomes, while providing a considerable increase in potential upside capture”.

Determine what is best for you

What if you want to consider an alternative to bonds in your portfolio? Making the best decision for your situation is especially important if you find yourself in the “retirement red zone” – the five-year period on either side of retirement. This is a time when protecting what you have accumulated over years of saving and investing should be a priority. As the return risk sequence shows, a large loss during this period can be disastrous for the rest of your retirement.

Maybe you’ll decide to keep some money in bonds after all, or maybe you just don’t want to give up that 60/40 split (or whatever you’ve got) because that’s what you’ve known all these years. . Maybe you go for the 60/20/20 mix, stepping out of bonds slightly but not completely. Or maybe you decide to ditch bonds altogether to see what fixed index annuities have in store for you.

Ultimately, it will be your decision, but your finance professional should be able to provide you with information and advice that will help you weigh the options in a more informed way.

That way, you can retire with more confidence — and with a better chance of achieving the secure future you seek.

Ronnie Blair contributed to this article.

Founder and Chairman, Wealth Trac Financial

Kurt Fillmore is founder and president of Wealth Trac Financial, an independent financial services firm based in Bingham Farms, Michigan, specializing in personalized wealth management and retirement planning. He is an investment representative and licensed insurance professional.

The appearances in Kiplinger were obtained through a public relations program. The columnist received help from a public relations firm to prepare this article for submission to Kiplinger.com. Kiplinger was not compensated in any way.

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