Written by: Cary Carney, Vice President of Sales at Kuvare, Guaranty Income Life Insurance Company, a Kuvare company.
Are you invested in a financial portfolio with 60% equities and 40% bonds with the goal of enabling those bonds to offset losses in the equity portion and secure a fixed income stream for retirement? We need to look at things differently today than 20 or 30 years ago when the 60/40 blend was popularized.
Yesteryear’s 60/40 strategy is looking like a bleak ongoing scenario at best. Nearly 40 years ago, U.S. government yields produced returns of approximately 14%. Now, those same yields are barely producing 1%. Four decades of high yields and falling interest rates created unstainable expectations for bonds as well as a desire to seek out these options for a large portion of a financial portfolio.
Although this worked well for quite some time, it’s troubling to see the outlook for bonds in the next several years and still believe a 60/40 strategy will allow the income you are counting on in retirement. It is imperative to learn about the current bond crisis and identify alternatives for passive fixed income.
The tables below illustrate historical bond yield declines and bleak future estimates.
Table 1: Average annualized returns and yield for investment grade bonds represented by the Bloomberg Barclays Aggregate Bond Index from Bloomberg L.P.
Table 2: 2021 capital market assumptions for broad investment grade (IG) U.S. bonds from five large asset managers. Source: Horizon Investments.
There are more attractive relative yield opportunities than bonds from an income perspective. As a diversifier, the effectiveness of bonds to buffer equity losses is certainly reduced. On a positive note, bonds don’t look much more susceptible to losses now than in the past. Although bonds have served as a great option historically, you may want to look elsewhere for the future. Alternatives to yesteryear’s bond strategies and fixed income could be today’s fixed index annuities.
Retirement income can come from more than just the yield; systematic distributions from an investment allocation can also fund retirement. However, if you continue to utilize the traditional methods to fund retirement through an allocation to bonds, the impact of compounding today’s poor future bond returns over many years could have a substantial impact on your retirement spending rate.
Looking at the tables above, the best-case historical bond market scenario for the past 30 years was a 6% annualized return. In the last decade, 4% is the average bond return, while 2% is the best case estimate for future bond returns.
For a 30-year retirement horizon, using the average returns from the last 30 years, a 6% bond return could have supported a withdrawal rate of roughly 6%. In comparison, with our best-case future scenario, a 2% bond return may support an estimated withdrawal rate of merely 3%. Here you can see that poor projected future bond returns could cut retirement spending by more than half – reinforcing the need to rethink retirement planning in a world now dominated by low interest rates.
Fortunately, there are alternatives like a fixed index annuity that could help in this low interest rate environment. Index annuities have the potential to earn on average more than the expected best-case scenario for bonds at 2%. An index annuity can also guarantee that you won’t incur any losses of your principle and offers the option to create a guaranteed income stream you can’t outlive. Depending on the product, that income stream could provide between 5% and 7% of your accumulation value. As an alternative for fixed income, this could be your ticket to saving for retirement – and a significantly better option than diversifying with bonds as done in the past.
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