Retirees with a heavy reliance on U.S. Treasury bonds for income may want to rethink their investment strategy.
With yields on Treasurys at historically low levels, these stalwart income-producers may be doing less for you than you intend. While they still provide the safety you might seek, there could be a better way to allocate your portfolio to ensure the value of your assets isn't eroding.
"There's a serious chance that the return on that portion of your portfolio won't keep pace with inflation," said Walt Nockett, principal and portfolio advisor at Sullivan, Bruyette, Speros & Blayney in McLean, Virginia.
"If that happens, you're looking at a negative real return — it won't maintain its purchasing power," said Nockett, a certified financial planner and chartered financial analyst.
While inflation is one of the ever-present risks with bond investing, the Federal Reserve recently indicated that it generally won't step in any time soon to stop it.
This effectively means that the central bank's typical reaction to the specter of inflation — raising its benchmark interest rate, which taps the brakes on assumed inflationary pressures — may not happen as soon as it would have otherwise. Thus, inflation could go above the target rate of 2% at some point.
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Aside from inflation risk, investing in a low-interest rate environment means you may want to look far beyond Treasurys in your pursuit of income.
"You have to have some flexibility, at least over the next few years, in the way you invest," said CFP Adam Reinert, chief investment officer with Marshall Financial Group in Doylestown, Pennsylvania.
Right now, the yield on the benchmark 10-year Treasury is below 1%. Shorter-duration Treasurys are, as well. In fact, on Friday, the one-year Treasury yield was below 0.2%.
"It makes it really hard to live off of income and coupon payments compared to in the past," Reinert said.
There are other options that could make sense for you.Â
First, Treasurys aren't the only bonds out there. Remember, a bond is basically the issuer's IOU — a government, corporation or agency borrows money from you with the promise of interest payments until you get your principal back (the bond's maturity).Â
If you are able to take a portion of your Treasurys allocation and put it toward higher-yielding bonds, that may make sense.
Corporate bonds with good credit ratings are yielding about 2% to 2.5%, Nockett said. Junk bonds — those with poor credit ratings — are pulling in about 4% to 4.5%. However, they come with the risk of default and volatility — in March, they were down 15%, Nockett said. He added, though, that they have since generally recovered those early year losses.
Instead of targeting, say, 4% in interest income in your portfolio, you try to target a 4% total return through [asset] appreciation, dividends and interest.Adam ReinertChief investment officer with Marshall Financial Group
Nockett said he doesn't recommend abandoning Treasurys altogether. For instance, if you typically would want eight years' worth of income in Treasurys, you could reduce that to four or five years' worth and put the remainder in those other bond types.
Alternatively, you could put some of that money into stocks or other investments that tend to offer higher returns. The S&P 500 index, for example, has a yearly average return of 10% with dividends reinvested (about 7.5% after inflation).
Incidentally, dividend-paying stocks can offer steady income without having to sell an asset. However, be aware that some companies have cut or suspended those payments this year due to pandemic-induced economic turmoil.
Of course, no moves should be made without assessing your risk tolerance. That's generally a combination of how long until you need the money and whether you can stomach the ups and downs that come with riskier investments. Generally speaking, though, the longer your time horizon, the more you can afford to have in stocks and other volatile assets.
You also may be better off rethinking, overall, your definition of income.
"Instead of targeting, say, 4% in interest income in your portfolio, you try to target a 4% total return through [asset] appreciation, dividends and interest,"Â Reinert said.
Additionally, a well-diversified portfolio can be useful. This helps reduce volatility overall in the value of your portfolio because your holdings wouldn't move in lockstep — so one investment may crater while another rises. This strategy could go beyond stocks and include things like real estate, gold or private equity. Most people also could benefit from some professional guidance, as well.
Above all, your entire investment approach should be determined in the context of your individual situation.
"You could have one retiree completely comfortable taking risk in equity, and someone else who's not," Reinert said.
"There has to be a way to structure a portfolio that works for each person and achieves their income objective," he said. "That's where being flexible comes into play, and rethinking what portfolio income means."